Kolby\'s Korndogs is looking at a new sausage system with an installed cost of $
ID: 2779994 • Letter: K
Question
Kolby's Korndogs is looking at a new sausage system with an installed cost of $938,000. This cost will be depreciated straight-line to zero over the project's seven-year life, at the end of which the sausage system can be scrapped for $113,000. The sausage system will save the firm $201,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $59,000 If the tax rate is 30 percent and the discount rate is 7 percent, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g, 32.16.) NPVSExplanation / Answer
CALCULATION OF OPERATIN CASH INFLOWS OVER THE PROJECT LIFE OF 7 YEARS
after tax savings in operating costs(201000 * 70%) 140700
tax savings on depreciation (117857.14 * 30%) = 35357.14 (note annual depreciation = (938000-113000)/7yrs
net operating cash inflow 176057.14
multiplied by present value interest factor for an annuity for 7yrs at 7%= 5.389
= 948771.93 = (A)
CALCULATION OF TERMINAL CASHFLOW
salvage value of machine received at the end of 7 years multiplied by present value interest factor of $1 at 7%, 7 years= 113000 * 0.623= 70339
recovery of working capital at the end of 7yrs= 59000 * 0.623= 36757
total terminal cashflow= 70339 + 36757= 107156=(B)
PRESENT VALUE OF ALL CASH INFLOWS = (A) +(B)= 948771.93 +107156= 1055927.93
CALCULATION OF INVESTMENT OUTLAY
cost of new asset + working capital= 938000 + 59000= 997000
NET PRESENT VALUE= present value of cash inflows - initial investment= 1055927.93- 997000= $58927.93
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