Dog Up! Franks is looking at a new sausage system with an installed cost of $455
ID: 2733087 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $455,000. 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 $65,000. The sausage system will save the firm $235,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $24,000. If the tax rate is 34 percent and the discount rate is 10 percent, what is the NPV of this project?Explanation / Answer
Initial investment = cost of system + working capital
= 455,000+24000
= 479,000
Annual deprecation = (cost of asset – salvage value)/ life
= (455,000 -0)/5
= 91,000
Operating cash flow = pretax income x (1- t) + depreciation x tax rate
= 235,000 x (1-0.34) + 91,000 x 0.34
= 155,100 + 30,940
= 186,040
Net salvage value = salvage value x (1-t)
= 65000 x (1-0.34)
= 42,900
Terminal cash flow = net salvage value + working capital recouped
= 42,900 + 24,000
= 66,900
Now we can discount all cash flows by multiplying with PV factor and compute NPV:
year
Cash flow
PV factor 10%
PV
0
-479000
1
-479000.00
1
186040
0.909090909
169127.27
2
186040
0.826446281
153752.07
3
186040
0.751314801
139774.61
4
186040
0.683013455
127067.82
5
186040
0.620921323
115516.20
5
66900
0.620921323
41539.64
NPV
267777.61
Therefore, NPV would be 267777.61.
year
Cash flow
PV factor 10%
PV
0
-479000
1
-479000.00
1
186040
0.909090909
169127.27
2
186040
0.826446281
153752.07
3
186040
0.751314801
139774.61
4
186040
0.683013455
127067.82
5
186040
0.620921323
115516.20
5
66900
0.620921323
41539.64
NPV
267777.61
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