Dog Up! Franks is looking at a new sausage system with an installed cost of $490

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $490,000. 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 $72,000. The sausage system will save the firm $170,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $31,000. If the tax rate is 30 percent and the discount rate is 8 percent, what is the NPV of this project?

Explanation / Answer

PV of cash flows are calculated as = cash flow/(1+i)^n, where is the discount rate which is 8% and n is the number of period.

Depreciation is calculated as (490,000 - 72000)/5 = 83,600

Year Fixed cost Increase in profit Increase in after tax profit Depreciation Proceed from sale of equipment Tax benefit from depreciation Working capital Cash flow PV of cash flows 0          490,000      31,000 (521,000) (521,000) 1          170,000    119,000              83,600                              25,080     144,080     133,407 2          170,000    119,000              83,600                              25,080     144,080     123,525 3          170,000    119,000              83,600                              25,080     144,080     114,375 4          170,000    119,000              83,600                              25,080     144,080     105,903 5          170,000    119,000              83,600                             72,000                              25,080      31,000     247,080     168,158 NPV     124,370

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