Dog Up! Franks is looking at a new sausage system with an installed cost of $491

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?

Explanation / Answer

A)Initial investment : Purchase cost+ working capital

                491400 +35280

            = $ 526680

B)Depreciation : 491400/5 = 98280

Net Incremental income before tax : 151200-98280 = 52920

Income after tax : 52920[1-.35]= 34398

Annual cash flow = 34398+ 98280 (depreciation) = 132678

c)Terminal value :

After tax sale value : 75600(1-.35)= 49140

Terminal value =after tax sale value+working capital realized

            = 49140+ 35280

          = $ 84420

Present value ; [PVA 14%,5* Annual cash flow ]+[PVF14%,5*Terminal value]

        =[3.43308*132678]+ [ .51937*84420]

       = 455494.32+ 43845.22

      = 499339.54

NPV =present value -Initial cost

        = 499339.54- 526680

              = - 27340.46

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