Dog Up! Franks is looking at a new sausage system with an installed cost of $530

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $530,000. 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 $210,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $39,000. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.) NPV

Explanation / Answer

Annual depreciation=(Cost-Salvage value)/USeful life

=(530000-0)/5=$106000/year

Hence annual operating cash flow=Pretax operating cost savings*(1-tax rate)+Tax savings on Annual depreciation

=$210000(1-0.35)+0.35*106000

=$173600

Inflow at the end of 5th year net of tax=$80000*(1-tax rate)

=$80000(1-0.35)=$52000

Initial cost=$(530000+$39000)=$569000

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=$173600/1.09+173600/1.09^2+173600/1.09^3+173600/1.09^4+173600/1.09^5+52000/1.09^5+$39000/1.09^5

[NOTE:Working capital would be released at the end of the 5th year]

=$734,387.2155

NPV=Present value of inflows-Present value of outflows

=$734,387.2155-$$569000

=$165387.22(Approx).

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