9.9 Dog Up! Franks is looking at a new sausage system with an installed cost of
ID: 2785566 • Letter: 9
Question
9.9
Dog Up! Franks is looking at a new sausage system with an installed cost of $273,000. This cost will be depreciated straight-line to zero over the project's 10-year life, at the end of which the sausage system can be scrapped for $42,000. The sausage system will save the firm $84,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $19,600.
rev: 09_18_2012
$119,686.68
$109,161.35
$121,204.70
$131,730.03
$125,671.02
Dog Up! Franks is looking at a new sausage system with an installed cost of $273,000. This cost will be depreciated straight-line to zero over the project's 10-year life, at the end of which the sausage system can be scrapped for $42,000. The sausage system will save the firm $84,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $19,600.
Explanation / Answer
Cost of installation =$273,000.
Life of the project=10 years.
Depreciation is straight line basis. =$273,000/10
=$27,300.
Savings in costs=$84,000
After tax savings in costs=$84,000*(1-.35)
=$54,600.------(1)
Tax savings on depreciation, and as this is not actual cash flow=$27,300.*35%
=$9,555.----------(2)
Total savings per year=(1)+(2)
=$64,155.-----(3).
Net working capital=$19,600-------(4)
After tax salvage value=$42,000 *(1-.35) (as the asset is totally depreciated)
=$42,000*.65
=$27,300.
Working capital recovered=$19,600
Therefore, net terminal cash flows in the 10th year=$27,300+$19,600.
=$46,900.
Therefore, NPV=Present value of cash outflows - Present value of cash inflows
Present value of cash outflows= $46,900.
Present value annuity factor for 10 years @10% =1-(1+.10)^-10/.10
=6.1445
Present value of cash inflows= $64,155*6.1445
=$394,204.70.------(A)
Present value of terminal cash inflows=$46,900.*(1/1.1^10)
=$18,081.98.-----(B).
Present value of cash inflows=(A)+(B)
=$412,286.68.-------(C)
NPV=$412,286.68 - ($273,000 +19,600)
=$119,686.68
Therefore, answer is first option, ie., $119,686.68.
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