Dog Up! Franks is looking at a new sausage system with an installed cost of $455
ID: 2777720 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $455,000. 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 $65,000. The sausage system will save the firm $235,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $24,000. 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
Answer:
a. Present Value of Cash Outflows = $ 455,000 (cost of new system) + $ 24,000 (initial net working capital investment) = $ 479,000
b. Present Value of Cash Inflows:
Annual Saving in operating cost = $ 235,000
Less: Depreciation per annum = $ 78,000 {($ 455,000 - $ 65,000) / 5}
Savings before tax = $ 157,000
Less: Tax @ 34% = $ 53,380
Savings after tax = $ 103,620
Add back Depreciation = $ 78,000
Net Annual Cash Inflow for 5 years = $ 181,620
Present Value of above annual net cash inflows = $ 181,620 x Present Value factor at 10% for 5 years = $ 181,620 x 3.79 = $ 688,340
Present Value of Salvage Value = $ 65,000 x Present value factor for 5th year at 10% = $ 65,000 x 0.62 = $ 40,300
Present Value of Working Capital released at the end of 5th year = $ 24,000 x 0.62 = $ 14,880
Total Present Value of Cash Inflows = $ 688,340 + $ 40,300 + $ 14,880 = $ 743,520
Net Present Value = PV of Cash Inflows - PV of cash outflows = $ 743,520 - $ 479,000 = $ 264,520
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