Question

Dog Up! Franks is looking at a new sausage system with an installed cost of $695,000. 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 $93,000. The sausage system will save the firm $199.000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $51,000. If the tax rate is 23 percent and the discount rate is 8 percent, what is the NPV of this project?

Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.

Answer 1

To calculate the NPV for Dog Up! Franks sausage system, one must consider initial installation and working capital costs, annual depreciation, annual savings, the salvage value, tax effects, and the discount rate over the 5-year project life.

Step-by-step explanation:

To calculate the Net Present Value (NPV) of the sausage system project for Dog Up! Franks, we must consider the initial cost, annual savings, salvage value at the end, depreciation, changes in net working capital, tax rate, and the discount rate.

The initial investment includes the installed cost of the system and the initial net working capital, which are $695,000 and $51,000, respectively. The sausage system will save the company $199,000 annually in pretax operating costs. Depreciation is straight-line over 5 years, which means the annual depreciation expense is $139,000. At the end of the project's life, the system can be scrapped for $93,000. With a tax rate of 23 percent, we must adjust the savings and final salvage value for taxes. The discount rate is used to calculate the present value of future cash flows.

Here is the calculation breakdown:

1. 
   
3. Annual depreciation expense: Installed cost / Project life = $695,000 / 5 = $139,000
4. 
   
6. Depreciation tax shield: Depreciation expense * Tax rate = $139,000 * 23% = $31,970
7. 
   
9. After-tax savings: (Annual savings - Depreciation expense) * (1 - Tax rate)
10. 
    
12. After-tax salvage value: (Salvage value - Book value at end of life) * (1 - Tax rate) = ($93,000 - $0) * 77% = $71,610
13. 
    
15. Calculate NPV using the formula: NPV = Σ (Cash flow in year t / (1 + discount rate)^t) - Initial investment

The initial investment is negative since it's an outflow. The annual after-tax savings and tax shield on depreciation add to the cash flows for the first five years. The after-tax salvage value adds to the cash flow at the end of year 5.

Answer 2

The NPV of the sausage system project is -$729,908.75.

How to solve

Here's a step-by-step solution to calculate the NPV of the sausage system project:

1. Calculate annual depreciation:

Annual depreciation = Installed cost / Useful life

Annual depreciation = $695,000 / 5 years = $139,000

2. Calculate annual operating cash flows:

Annual operating cash flows = Annual savings - Depreciation

Annual operating cash flows = $199,000 - $139,000 = $60,000

3. Calculate annual after-tax operating cash flows:

Annual after-tax operating cash flows = Annual operating cash flows * (1 - Tax rate)

Annual after-tax operating cash flows = $60,000 * (1 - 0.23) = $46,200

4. Calculate the terminal cash flow:

Terminal cash flow = Salvage value - Depreciation in the final year

Terminal cash flow = $93,000 - $139,000 = -$46,000

5. Calculate the present value of cash flows:

Year Cash Flow Discount Factor Present Value

1 -$695,000 - $51,000 1 / (1 + 0.08) -$807,487.96

2 $46,200 1 / (1 + 0.08)^2 $42,551.58

3 $46,200 1 / (1 + 0.08)^3 $38,839.03

4 $46,200 1 / (1 + 0.08)^4 $35,598.34

5 $46,200 - $46,000 1 / (1 + 0.08)^5 $200.00

6. Calculate the NPV:

NPV = Sum of present values of cash flows

NPV = -$807,487.96 + $42,551.58 + $38,839.03 + $35,598.34 + $200.00 = -$729,908.75

Therefore, the NPV of the sausage system project is -$729,908.75.