Dog Up! Franks is looking at a new sausage system with an installed cost of $525

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $525,000. 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 $79,000. The sausage system will save the firm $205,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $38,000. If the tax rate is 34 percent and the discount rate is 10 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

Installation Cost 525,000

Residual value 79,000

Useful life         5 year

Savings in pretax operating cost 205,000

Initial investment in net working capital 38,000

Tax rate 34%

Discount rate 10%

NPV=Present value of cash inflows –Present value of cash outflows

According to net present value method, it should purchase the new sausage system because the present value of the cost savings is greater than the present value of the initial cost to purchase and install the machine. Here are the computations:

Item                Years       Amount of cash flow      10% factor      Present value of cash flow

Saving             1-5        205,000                        3.791                777155

Salvage value    5            79,000                          3.791                 299489

Initial investment 0           525,000+38000             1                         563,000

Net Present value=777155+299489-563000=513644

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