Dog Up! Franks is looking at a new sausage system with an installed cost of $491
ID: 2789291 • Letter: D
Question
Dog Up! Franks is looking at a new sausage system with an installed cost of $491,400. This cost will be depreciated straight-line to zero over the project's 5-year life, at the end of which the sausage system can be scrapped for $75,600. The sausage system will save the firm $151,200 per year in pretax operating costs and the system requires an initial investment in net working capital of $35,280. Required: If the tax rate is 35 percent and the discount rate is 14 percent, what is the NPV of this project? o $35,905.68 O$-52,862.36 $-27,340.58 O $-10,383.91 O $-28,70761Explanation / Answer
Year
Cash Flow(C)
PV Factor Formula
PV Factor(F) ‘@ 14%
PV(=C x F)
0
($526,680)
1/(1+0.14)^0
1
($526,680.00)
1
$ 132,678
1/(1+0.14)^1
0.877192982
$116,384.21
2
$ 132,678
1/(1+0.14)^2
0.769467528
$102,091.41
3
$ 132,678
1/(1+0.14)^3
0.674971516
$89,553.87
4
$ 132,678
1/(1+0.14)^4
0.592080277
$78,556.03
5
$167,958
1/(1+0.14)^5
0.519368664
$87,232.12
NPV
($52,862.36)
Option 2nd “-52,862.36” is correct answer
Explanation for cash flows:
Initial investment = Initial cost + installation +capital investment
= - $ 491,400 - $ 35,280 = - $ 526,680
Year 1st through 4th cash flow:
Depreciation = (Initial cost + installation)/useful life = $ 491,400/5 = $ 98,280
[Scrap value is often considered as 0]
Pretax operating cost savings or profit = $ 151,200
Tax amount = 35 % or 0.35
After-tax operating cost savings = (Pretax operating cost savings–depreciation) x (1–0.35) + Depreciation
= ($ 151,200 - $ 98,280) x 0.65 + $ 98,280
= $ 52,920 x 0.65 = $ 34,398 + $ 98,280
= $ 132,678
Year 5th cash flow = Previous cash inflow + working capital release
= $ 132,678 + $ 35,280 = $ 167,958
Year
Cash Flow(C)
PV Factor Formula
PV Factor(F) ‘@ 14%
PV(=C x F)
0
($526,680)
1/(1+0.14)^0
1
($526,680.00)
1
$ 132,678
1/(1+0.14)^1
0.877192982
$116,384.21
2
$ 132,678
1/(1+0.14)^2
0.769467528
$102,091.41
3
$ 132,678
1/(1+0.14)^3
0.674971516
$89,553.87
4
$ 132,678
1/(1+0.14)^4
0.592080277
$78,556.03
5
$167,958
1/(1+0.14)^5
0.519368664
$87,232.12
NPV
($52,862.36)
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