Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $410,000. 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 $70,000. The sausage system will save the firm $115,000 per year in pretax operating costs, and the system requires an initial investment in new working capital of $15,000. If the tax rate is 34% and the discount rate is 10%, what is the NPV of this project?

Please explain how to solve WITHOUT excel. Thank you

Answer 1

The cost of installing the sausage system is :

CF0 = ($410,000) + INVESTMENT IN WORKING CAPITAL

= ($410,000) + ($15,000)

= ($425,000)

The depreciation expense as per the straight line formula is :

= $410,000/ 5

= $82,000

CF1 = $115,000 * (1 - 0.34) + depreciation tax shield

= 115,000* 0.66 + 0.34* $82,000

= $75,900 + $27,880

=$103,780

CF1 TO CF4 = $103,780

CF5 = $103,780 + AFTER TAX SALVAGE VALUE + RECOVERY OF WORKING CAPITAL

= $103,780 + $70,000 * (1 - 0.34) + $15,000

= $164,980

At discount rate of 10%, the NPV is : $6408.2359

= $6408.24 ( rounded off to two decimal places)