Dog Up! Franks is looking at a new sausage system with an installed cost of $440
ID: 2775832 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $440,000. 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 $62,000. The sausage system will save the firm $250,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $21,000. If the tax rate is 34 percent and the discount rate is 10 percent, what is the NPV of this project?
Explanation / Answer
Initial Capital Investment = $440,000
Initial investment in net working capital = $21,000
Total Initial Investment = Initial Capital Investment + Initial investment in net working capital = 440,000 + 21,000
= $461,000
Yearly Depreciation = (Initial Value - Residual Value) / No of Years = (440000 - 0) /5 = 440000/5 = $88000
For years 1 to 5,
Saving in pre tax cost = $250,000
Depreciation = $88,000
Cash Flow = 250,000 * (1 - Tax rate) + Tax shield on Depreciation
= 250,000 * (1 - 34%) + 34%* 88000
= 165,000 + 29920 = $194,920
For year 5,
Scrap Value = $62,000
Book Value = $0
Post Tax Proceeds from Disposal of Asset = 62000 * (1 -34%) = $40,920
Terminal Cash Flow = Post Tax Proceeds from Disposal of Asset + Recovery of Net Working Capital
= 40920 + 21000 = $61920
Total Cash Flow in Year 5 = Operating Cash Flow + Terminal Cash Flow = 194920 + 61920 = $256,840
Discount Rate = 10%
Thus, the cash flows look like this:
Thus, NPV of the project is the sum of discounted cash flows = $316,347.61
Year Cash Flow Discounted Cash Flow 0 -461000 -461000.00 1 194920 177200.00 2 194920 161090.91 3 194920 146446.28 4 194920 133132.98 5 256840 159477.43 NPV 316347.61Related Questions
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