Symon Meats is looking at a new sausage system with an installed cost of $455,00
ID: 2657755 • Letter: S
Question
Symon Meats 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 equipment + net working capital
Initial Investment = 455,000 + 24,000 = $479,000
Annual depreciation = 455,000 / 5 = 91,000
Operating cash flow from year 1 through 5 = ( savings - depreciation )( 1 - tax ) + depreciation
Operating cash flow from year 1 through 5 = ( 235,000 - 91,000)( 1 - 0.34) + 91,000
Operating cash flow from year 1 through 5 = $186,040
Year 5 non operating cash flow = sale + net working capital - tax ( sale value - book value)
Year 5 non operating cash flow = 65,000 + 24,000 - 0.34 ( 65,000 - 0)
Year 5 non operating cash flow = 41,000 - 0.34 ( 65000)
Year 5 non operating cash flow = $18,900
NPV = Present value of cash inflows - present value of cash outflows
NPV = -479,000 + 186,040 / ( 1 + 0.1)1 + 186,040 / ( 1 + 0.1)2 + 186,040 / ( 1 + 0.1)3 + 186,040 / ( 1 + 0.1)4 + 186,040 / ( 1 + 0.1)5 + 18,900 / ( 1 + 0.1)5
NPV = $237,973.38
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