Dog Up! Franks is looking at a new sausage system with an installed cost of $569

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $569,400. This cost will be depreciated straight-line to zero over the project's 7-year life, at the end of which the sausage system can be scrapped for $87,600. The sausage system will save the firm $175,200 per year in pretax operating costs, and the system requires an initial investment in net working capital of $40,880.

Required: If the tax rate is 33 percent and the discount rate is 9 percent, what is the NPV of this project?

Explanation / Answer

Depreciation = 569400/7 = 81343

Tax Saving on depreciation = 81343*0.33 = $26843

Present Value of Tax Saving on depreciation = 26843*5.033 = $135100                               A.

Saving post tax per year = 175200*(1-0.33) = $117384

Present Value of Savings post tax = 117384 * 5.033 = $590794                                            B.

Present Value of Scrap net of tax = 87600*(1-0.33)*0.547 = $32105                                    C.

Present Value of Reversal of Net Working Capital = 40880*0.547 = $22361                         D.

Present Value of Cash Inflows = A + B + C + D = 135100 + 590794 + 32105 + 22361 = $780360

Cash Outflows = Purchase Price + Working Capital = 569400 + 40880 = $610280

NPV = Present Value of Cash Inflows - Cash Ouflows = 780360 - 610280 = $170080

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