Question

Fox Hollow Franks is looking at a new system with an installed cost of $540,000. This equipment is depreciated at a rate of 20% per year (Class 8) over the project’s five-year life, at the end of which the sausage system can be sold for $80,000. The sausage system will save the firm $170,000 per year in pre-tax operating costs, and the system requires an initial investment in net working capital of $29,000. If the tax rate is 34% and the discount rate is 10%, what is the NPV of this project? (Do not round your intermediate calculations. Round the final answer to 2 decimal places. Omit $ sign in your response.)

 

NPV 

Answer 1

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. 

Year, n	Linkage	0	1	2	3	4	5
Asset cost	A	540000
Class 8 depreciation rate	d	20%
Opening balance			540,000	432,000	345,600	276,480	221,184
Depreciation	D		108,000	86,400	69,120	55,296	44,237
Closing balance			432,000	345,600	276,480	221,184	176,947
Sale Value	S						80,000
Gain / (Loss) on sale	B = S - closing balance of year 5						(96,947)
Tax	T = B x 34%						(32,962)
Post tax salvage value	C = S - T						112,962
Cash flows
Asset cost	A	(540,000)
Savings in pre tax operating cost	E		170,000	170,000	170,000	170,000	170,000
[-] Depreciation	D		108,000	86,400	69,120	55,296	44,237
EBIT	F = E - D		62,000	83,600	100,880	114,704	125,763
NOPAT	G = F x (1 - 34%)		40,920	55,176	66,581	75,705	83,004
OCF	H = G + D		148,920	141,576	135,701	131,001	127,241
Working capital	I	(29,000)					29,000
Post tax salvage value	C from above						112,962
Net cash flows	CF = A + H + I + C	(569,000)	148,920	141,576	135,701	131,001	269,203
Discount rate	r	10%
PV factor	PVF = (1 + r)^(-n)	1.0000	0.9091	0.8264	0.7513	0.6830	0.6209
PV of cash flows	CF x PVF	(569,000)	135,382	117,005	101,954	89,475	167,154
NPV	Sum of all PVs	41,969.61