Kolby’s Korndogs is looking at a new sausage system with an installed cost of $5
ID: 2715425 • Letter: K
Question
Kolby’s Korndogs is looking at a new sausage system with an installed cost of $538,000. This cost will be depreciated straight-line to zero over the project’s four-year life, at the end of which the sausage system can be scrapped for $114,000. The sausage system will save the firm $202,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $60,000. If the tax rate is 40 percent and the discount rate is 9 percent, what is the NPV of this project?
Explanation / Answer
Solution :
Step 1 : Initial Outflow
a. Capital Expenditure $ 538,000
b. Working Capital $ 60,000
c. Net Investment(a+b) = $ 598,000
Step 2: Operating Flows( in $)
a. Annual Savings 202,000
b. Depreciation 106,000
c. Profit Before Tax (a-b) 96,000
d. Tax (40%) 38,400
e. Profit After Tax9 c-d) 57,600
f. CFAT (e+b) 163,600
Depreciation = [ (Original Cost- Salvage Value) /Life]
= [ (538,000-114,000) / 4]
= 106,000
c. Terminal Flow (in $)
a. Net sale Value of the sausage system 114,000
b. Recapture of Working Capital 60,000
c. Net Terminal Value (a+b) 174,000
Step 4: Capital Budgetiing Analysis Statement (in $)
Year Cash Flow Discounting Factor (9%) Discounted Cash Flow
0 (538,000) 1 (538,000)
1-4 163,600 3.2387 529,851.32
4 174,000 0.708 123,192
NPV 115,043.32
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