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Kolby’s Korndogs is looking at a new sausage system with an installed cost of $7

ID: 2710067 • Letter: K

Question

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $765,000. This cost will be depreciated straight-line to zero over the project’s six-year life, at the end of which the sausage system can be scrapped for $100,000. The sausage system will save the firm $188,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $46,000.

If the tax rate is 35 percent and the discount rate is 7 percent, what is the NPV of this project?

Kolby’s Korndogs is looking at a new sausage system with an installed cost of $765,000. This cost will be depreciated straight-line to zero over the project’s six-year life, at the end of which the sausage system can be scrapped for $100,000. The sausage system will save the firm $188,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $46,000.

Explanation / Answer

Kolby's Korndogs Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Discount factor @7% 1 0.935 0.873 0.816 0.763 0.713 0.666 Investment         (765,000) Net Working Capital           (46,000) Depreciation            127,500            127,500            127,500            127,500            127,500            127,500 Increase in revenue/Saving in opearting cost            188,000            188,000            188,000            188,000            188,000            188,000 Salvage value            100,000 Total Pretax earning            188,000            188,000            188,000            188,000            188,000            288,000 Income Tax @35%               65,800               65,800               65,800               65,800               65,800            100,800 Post Tax Cash Inflow            122,200            122,200            122,200            122,200            122,200            187,200 Add Depreciation Tax shield @35% on Depreciation               44,625               44,625               44,625               44,625               44,625               44,625 Add back depreciation            127,500            127,500            127,500            127,500            127,500            127,500 Total Cash Flow            294,325            294,325            294,325            294,325            294,325            359,325 PV of cash flow        1,446,224            275,070            257,075            240,257            224,539            209,850            239,433 NPV           635,224