Dog Up! Franks is looking at a new sausage system with an installed cost of $460
ID: 2714905 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $460,000. 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 $66,000. The sausage system will save the firm $230,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $25,000. If the tax rate is 30 percent and the discount rate is 8 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))
Dog Up! Franks is looking at a new sausage system with an installed cost of $460,000. 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 $66,000. The sausage system will save the firm $230,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $25,000. If the tax rate is 30 percent and the discount rate is 8 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))
Explanation / Answer
Annual depreciation = (cost of asset – salvage value)/ life
=(460,000 -0)/ 5
= 92,000
Depreciation tax shield = annual depreciation x tax rate
= 92,000 x 30%
= 27,600
Net salvage value = salvage value x (1- tax rate)
= 66000 x (1-0.30)
= 46,200
Year
0
1
2
3
4
5
cost of system
-460000
annual cost saving
230000
230000
230000
230000
230000
Tax 30%
-69000
-69000
-69000
-69000
-69000
Net cash saving
161000
161000
161000
161000
161000
Depreciation tax shield
27600
27600
27600
27600
27600
Net working capital
-25000
25000
Net salvage value
46200
Total cash flow
-485000
188600
188600
188600
188600
259800
Year
Total cash flow
PV Factor 8%
PV
0
-485000
1
-485000
1
188600
0.925926
174629.6
2
188600
0.857339
161694.1
3
188600
0.793832
149716.8
4
188600
0.73503
138626.6
5
259800
0.680583
176815.5
NPV
316482.6
Hence, NPV would be 316482.6.
Year
0
1
2
3
4
5
cost of system
-460000
annual cost saving
230000
230000
230000
230000
230000
Tax 30%
-69000
-69000
-69000
-69000
-69000
Net cash saving
161000
161000
161000
161000
161000
Depreciation tax shield
27600
27600
27600
27600
27600
Net working capital
-25000
25000
Net salvage value
46200
Total cash flow
-485000
188600
188600
188600
188600
259800
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