The Sausage Hut is looking at a new sausage system with an installed cost of $43

Question

The Sausage Hut is looking at a new sausage system with an installed cost of $438,000. This cost will be depreciated straight-line to zero over the project's 4-year life, at the end of which the sausage system can be scrapped for $69,000. The sausage system will save the firm $129,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $29,000, which will be recouped at project end. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project?

Can anyone explain this step by step for someone who is TERRIBLE at finance?:(

Explanation / Answer

1)Initial investment = 438000 + 29000 = 467,000

2)Present value of cash inflows:

Present value of after tax savings in operating cost = cost * (1-tax) *PVAF@9%,4

                                                                  = 129000(1-.35) *3.23972

                                                                   = 129000 *.65 *3.23972

                                                                   = 271,650.52

B)Depreciation = 438000 /4

                       = 109500

Present value of Tax saving on depreciation = 109500 * .35 * 3.23972 = 124,162.27

c)Present value of after tax scrap value at end of year4 =PVF@9%,4 *Sale value (1-t)

                                                     = .70843 * 69000 (1-.35)

                                                      =31772.87

Present of net working capital = .70843 * 29000 = 20544.47

Total present value = 271,650.52 + 124,162.27+31772.87+20544.47 = 448130.13

NPV = Present value -Initial cost

       = 448130.13 - 467000

           = -18869.87

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