Dog Up! Franks is looking at a new sausage system with an installed cost of $348
ID: 2750938 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $348,950. This cost will be depreciated straight-line to zero over the project's six-year life, at the end of which the sausage system can be scrapped for $50,000. The sausage system will save the firm $134,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $19,500. All of the net working capital will be recovered at the end of the project. The tax rate is 35 percent and the discount rate is 12 percent. What is the net present value of this project?
Next year, Jensen’s will pay an annual dividend of $2.75 per share. The company has been reducing the dividends by 10 percent annually. How much are you willing to pay today to purchase stock in this company if your required rate of return is 11.5 percent?
Oil Wells offers 6.5 percent coupon bonds with semiannual payments and a yield to maturity of 6.94 percent. The bonds mature in seven years. What is the market price per bond if the face value is $1,000?
You have just made a $1,500 contribution to your individual retirement account. Assume you earn a rate of return of 8.7 percent and make no additional contributions. How much more will your account be worth when you retire in 25 years than it would be if you waited another 5 years before making this contribution?
Dog Up! Franks is looking at a new sausage system with an installed cost of $348,950. This cost will be depreciated straight-line to zero over the project's six-year life, at the end of which the sausage system can be scrapped for $50,000. The sausage system will save the firm $134,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $19,500. All of the net working capital will be recovered at the end of the project. The tax rate is 35 percent and the discount rate is 12 percent. What is the net present value of this project?
Explanation / Answer
ANSWER = A) $109,622.83
Present value of cash outflow
Particulars
(at Y= 0) Amount
Cash outflow (installation cost)
348950
Working capital
19500
Total cash outflow
368450
PVF (Y=0)
1
Present value of cash outflow
368450
Present value of cash Inflow
Particulars
Year 1 to5
Year =6
Net annual cash flows from saving of operating cost (a)
$134,400
$134,400
Less- depreciation
$ 58,158.33
$ 58,158.33
Annual savings of operating cost
$ 76,241.67
$ 76,241.67
Less- tax @35% (b)
$ 26,684.58
$ 26,684.58
Cash flow after tax (a-b)
$ 107715.42
$ 107715.42
Add- scrapped value
50000
Add- working capital
19500
Net annual cash flow
$ 107715.42
177215.42
Present value factor
3.60478
0.50663
PV of cash inflow
388290.39
89782.65
Present value of cash Inflow= 478072.83
NET PRESENT VALUE = Present value of cash Inflow - Present value of cash outflow
= 478072.83 - 368450 = 109622.83
Price of share today = d1 / (Ke- g)
d1 = d0 * (1 + g)
d1 = 2.75* [1 + (-10%)] = 2.475
Price = 2.475 / [ 11.5% - (-10%)] = $165
Price willing to pay today to purchase stock in this company = interest* cummulative present value factor + FV * present value factor
= 32.5 * 10.94 + 1000 * 0.620
=$ 975.63
Semi annual interst = 1000 * 6.5% * 1 /2 = 32.5
Yeild rate = 6.94/2 = 3.47 %,
Life = 7 * 2 = 14 years for Annuity factor
cummulative PVF for 14 years at 3.47% = 10.9425, at year 14th = 0.620
Particulars
(at Y= 0) Amount
Cash outflow (installation cost)
348950
Working capital
19500
Total cash outflow
368450
PVF (Y=0)
1
Present value of cash outflow
368450
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