Question

Franks is looking at a new sausage system with an installed cost of $660,000. 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 $86,000. The sausage system will save the firm $185,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $37,000. If the tax rate is 21 percent and the discount rate is 9 percent, what is the NPV of this project?

Answer 1

The NPV of the project is $114,222.92.

Step-by-step explanation:

To calculate the NPV of the project, we need to find the present value of the cash inflows and outflows. The cash inflows include the savings in pretax operating costs, which is $185,000 per year for 5 years. At a discount rate of 9% and a tax rate of 21%, the present value of these cash inflows is calculated to be $765,852.30. The cash outflows include the initial investment in net working capital of $37,000 and the cost of the sausage system, which will be depreciated straight-line to zero over 5 years. Considering the salvage value of $86,000 at the end of the project's life, the present value of these cash outflows is calculated to be $651,629.38. Therefore, the NPV of this project is the difference between the present value of the cash inflows and outflows, which is $114,222.92.

Answer 2

The NPV of the project is $425,318.76.

Step-by-step explanation:

To calculate the NPV of the project, we need to sum up the present values of all cash flows associated with it. First, we calculate the annual cash flow by subtracting the pretax operating cost savings from the depreciation expense. In this case, the annual cash flow is $185,000 - ($660,000 - $86,000) / 5 = $119,000. Next, we find the present value of each annual cash flow using the discount rate of 9%.

The present value for each year is as follows:

• Year 1: $119,000 / (1 + 0.09) = $109,174.31
• Year 2: $119,000 / (1 + 0.09)^2 = $100,160.28
• Year 3: $119,000 / (1 + 0.09)^3 = $91,945.90
• Year 4: $119,000 / (1 + 0.09)^4 = $84,445.32
• Year 5: $119,000 / (1 + 0.09)^5 = $77,592.95

Lastly, we subtract the initial net working capital investment of $37,000 to find the total present value:

Total present value = $109,174.31 + $100,160.28 + $91,945.90 + $84,445.32 + $77,592.95 - $37,000 = $425,318.76

Therefore, the NPV of the project is $425,318.76.