Question

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $720,000. This cost will be depreciated straight-line to zero over the project’s 6-year life, at the end of which the sausage system can be scrapped for $98,000. The sausage system will save the firm $209,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $61,000. If the tax rate is 23 percent and the discount rate is 9 percent, what is the NPV of this project?

Answer 1

Time line		0	1	2	3	4	5	6
Cost of new machine		-720000
Initial working capital		-61000
=Initial Investment outlay		-781000
									100.00%
Savings			209000	209000	209000	209000	209000	209000
-Depreciation	Cost of equipment/no. of years		-120000	-120000	-120000	-120000	-120000	-120000	0	=Salvage Value
=Pretax cash flows			89000	89000	89000	89000	89000	89000
-taxes	=(Pretax cash flows)*(1-tax)		68530	68530	68530	68530	68530	68530
+Depreciation			120000	120000	120000	120000	120000	120000
=after tax operating cash flow			188530	188530	188530	188530	188530	188530
reversal of working capital								61000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)							75460
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								136460
Total Cash flow for the period		-781000	188530	188530	188530	188530	188530	324990
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624	1.6771001
Discounted CF=	Cashflow/discount factor	-781000	172963.3028	158681.9291	145579.7515	133559.41	122531.56	193780.92
NPV=	Sum of discounted CF=	146096.87