Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $530,400. This cost will be depreciated straight-line to zero over the project's 6-year life, at the end of which the sausage system can be scrapped for $81,600. The sausage system will save the firm $163,200 per year in pretax operating costs, and the system requires an initial investment in net working capital of $38,080.

  

If the tax rate is 22 percent and the discount rate is 10 percent, what is the NPV of this project?

Multiple Choice

• $92,123.54

• $144,636.01

• $128,051.18

• $134,453.74

• $108,708.38

Answer 1

Answer is $128,051.18

Initial Investment = $530,400
Useful Life = 6 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $530,400 / 6
Annual Depreciation = $88,400

Initial Investment in NWC = $38,080

Salvage Value = $81,600

After-tax Salvage Value = $81,600 * (1 - 0.22)
After-tax Salvage Value = $63,648

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $163,200 * (1 - 0.22) + 0.22 * $88,400
Annual Operating Cash Flow = $163,200 * 0.78 + 0.22 * $88,400
Annual Operating Cash Flow = $146,744

Required return = 10%

NPV = -$530,400 - $38,080 + $146,744/1.10 + $146,744/1.10^2 + … + $146,744/1.10^5 + $146,744/1.10^6 + $38,080/1.10^6 + $63,648/1.10^6
NPV = -$568,480 + $146,744 * (1 - (1/1.10)^6) / 0.10 + $101,728 * (1/1.10)^6
NPV = -$568,480 + $146,744 * 4.355261 + $101,728 * 0.564474
NPV = $128,051.18