Dog Up! Franks is looking at a new sausage system with an installed cost of $505

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $505,000. 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 $75,000. The sausage system will save the firm $185,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $34,000. 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

Initial Investment = Machine Cost + Investment in Working Capital

Initial Investment = 505000 + 34000

Initial Investment =541000

Annual Depreciation = Cost/Useful Life

Annual Depreciation = 505000/5

Annual Depreciation = 101000

Terminal Value = Post Tax Salvage Value + Working Capital realised back

Terminal Value = 75000*(1-30%) + 34000

Terminal Value = 86500

Annual Operating Cash Flow = Saving in pretax operating costs *(1-tax rate) + Annual Depreciation*Tax rate

Annual Operating Cash Flow = 185000*(1-30%) + 101000*30%

Annual Operating Cash Flow = 159800

NPV = -Initial Investment + Annual Operating Cash Flow *(1-(1+r)^-n)/r + Terminal value*(1+r)^-n

NPV = - 541000 + 159800*(1-(1+8%)^-5)/8% + 86500*(1+8%)^-5

NPV = $ 155,905.51

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