13. Project Evaluation [LOI] Dog Up! Franks is looking at a new sausage system w

Question

13. Project Evaluation [LOI] Dog Up! Franks is looking at a new sausage system with an installed cost of $540,000. This cost will be depreciated straight-line to zero over the project's five-year life, at the end of which the sausage system can be scrapped for $80,000 The sausage system will save the firm S170,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000. If the tax rate is 34 percent and the discount rate is 10 percent, what is the NPV of this project

Explanation / Answer

Cost of Equipment = $540,000
Useful Life = 5 years

Annual Depreciation = Cost of Equipment / Useful Life
Annual Depreciation = $540,000 / 5
Annual Depreciation = $108,000

Salvage Value = $80,000

After-tax Salvage Value = Salvage Value * (1 - tax)
After-tax Salvage Value = $80,000 * (1 - 0.34)
After-tax Salvage Value = $52,800

Initial NWC required = $29,000

Annual OCF = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual OCF = $170,000 * (1 - 0.34) + 0.34 * $108,000
Annual OCF = $148,920

NPV = -$540,000 - $29,000 + $148,920 * PVA of $1 (10%, 5) + $52,800 * PV of $1 (10%, 5) + $29,000 * PV of $1 (10%, 5)
NPV = -$540,000 - $29,000 + $148,920 * 3.7908 + $52,800 * 0.6209 + $29,000 * 0.6209
NPV = $46,315.56

So, NPV of the Project is $46,315.56

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