Question

Kolby's Korndogs is looking at a new sausage system with an installed cost of $655,000. This cost will be depreciated straightline to zero over the project's five-year life, at the end of which the sausage system can be scrapped for $85,000. The sausage system will save the firm $183,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $35,000. If the tax rate is 22 percent and the discount rate is 8 percent, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV

Answer 1

Initial investment = Cost + increase NWC

Initial investment = 655,000 + 35,000

Initial investment = 690,000

Annual depreciation = 655,000 / 5

Annual depreciation = 131,000

OCF from year 1 to year 5 = (Savings - depreciation)(1 - tax) + depreciation

OCF from year 1 to year 5 = (183,000 - 131,000)(1 - 0.22) + 131,000

OCF from year 1 to year 5 = 40,560 + 131,000

OCF from year 1 to year 5 = 171,560

Year 5 non operating cash flow = market value + NWC - tax(market value - book value)

Year 5 non operating cash flow = 85,000 + 35,000 - 0.22(85,000 - 0)

Year 5 non operating cash flow = 85,000 + 35,000 - 18,700

Year 5 non operating cash flow = 101,300

NPV = Present value of cash inflows - present value of cash outflows

NPV = -690,000 + 171,560 / (1 + 0.08)¹ + 171,560 / (1 + 0.08)² + 171,560 / (1 + 0.08)³ + 171,560 / (1 + 0.08)⁴ + 171,560 / (1 + 0.08)⁵ + 101,300 / (1 + 0.08)⁵

NPV = $63,932.41