Symon Meats is looking at a new sausage system with an installed cost of $450,00

Question

Symon Meats is looking at a new sausage system with an installed cost of $450,000. 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 $64,000. The sausage system will save the firm $240,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $23,000. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project?

Explanation / Answer

Solution:

To compute the Net present value of the project we discount at the rate and arrive at the NPV.

If the NPV is positive then it indicates that the project is profitable and can be invested and if negative then there is no adequate future cash flow.

The cash flow for 5 years would be = (240000*(1-.35)) = 1,56,000

I have explained it below the net present value:

Symon Meats Year Cash flow Discount rate @9% Present value 0 -450000                               1,00 -               450 000,00 0 -23000                               1,00 -                 23 000,00 1 156000                               0,92                  143 119,27 2 156000                               0,84 131 302,08 3 156000                               0,77 120 460,62 4 156000                               0,71                  110 514,33 5 156000                               0,65 101 389,30 Salvage 5 64000                               0,65 41 595,61 Net present value             175 381,2058

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