Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $470,000. 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 $63,000. The sausage system will save the firm $144,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $27,500. If the tax rate is 23 percent and the discount rate is 11 percent, what is the NPV of this project?

Answer 1

Initial investment = 470,000 + 27,500 = 497,500

Annual depreciation = 470,000 / 5 = 94,000

Operating cash flow from year 1 to year 5 = (Savings - depreciation)(1 - tax) + depreciation

Operating cash flow from year 1 to year 5 = (144,000 - 94,000)(1 - 0.23) + 94,000

Operating cash flow from year 1 to year 5 = 38,500 + 94,000

Operating cash flow from year 1 to year 5 = 132,500

Non operating cash flow for year 5 = Market value + NWC - tax(market value - book value)

Non operating cash flow for year 5 = 63,000 + 27,500 - 0.23(63,000 - 0)

Non operating cash flow for year 5 = 63,000 + 27,500 - 14,490

Non operating cash flow for year 5 = $76,010

NPV = Present value of cash inflows - present value of cash outflows

NPV = -497,500 + 132,500 / (1 + 0.11)¹ + 132,500 / (1 + 0.11)² + 132,500 / (1 + 0.11)³ + 132,500 / (1 + 0.11)⁴ + 132,500 / (1 + 0.11)⁵ + 76,010 / (1 + 0.11)⁵

NPV = $37,314.60