Dog Up! Franks is looking at a new sausage system with an installed cost of $485

Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $485,000. 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 $71,000. The sausage system will save the firm $165,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $30,000. If the tax rate is 35 percent and the discount rate is 9 percent, what is the NPV of this project?

Explanation / Answer

Calculation of depreciation per year,

Since, cost will be depreciated straight line to zero, therefore depreciation = $485000/5 = $97000 per year

Net Present value of outflow:

Cost plus Initial investment in net working capital = $485000+$30000 = $515000

Net present value of inflow:

Calculation of cash inflow

Year 1,2,3,4

Net profit = $165000-$97000 = $68000 per year

Net Profit after tax = $68000-($68000*35%) = $44200 per year

Cash flow after tax = $44200+$97000 (depreciation) = $141200 per year

Discounted Cash flow for year 1 to year 4 = ($141200* 3.24) = $457488

Year 5

Net profit = $165000-$97000+$71000(scrap value) = $139000

Net profit after tax = $139000-($139000*35%)= $90350

Cash flow after tax = $90350+$97000 = $187350

Discounted cash flow for year 5 = $187350+$30000(Net working capital realised at the end of the period)= $217350*0.65 = $141277.5

Total Present value of cash inflow = $457488+$141277.5 = $598765.5

Net present value of the project = $598765.5 - $515000 = $83765.5

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