Question

Kolby's Korndogs is looking at a new sausage system with an installed cost of $635,000. 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 $99,000. The sausage system will save the firm $187,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $45,000.

Required: If the tax rate is 34 percent and the discount rate is 8 percent, what is the NPV (Net Present Value) of this project?
A) $82,370
B) $121,370
C) $212,370
D) $45,000

Answer 1

To calculate the NPV for Kolby's Korndogs' new sausage system, one must account for initial investment, annual operating cost savings, tax implications of depreciation, salvage value, recovery of net working capital, and discount the resulting cash flows at the given discount rate.

Step-by-step explanation:

The determination of the Net Present Value (NPV) for Kolby's Korndogs new sausage system requires the consideration of initial investment, salvage value at the end of the project's life, annual savings in operating costs, non-operating initial investment in net working capital, and the tax effects of depreciation. The tax shield provided by depreciation and salvage value needs to be accounted for along with the tax effect on the annual operational savings. The cash flows over the life of the project, including the end of life salvage minus the recovery of working capital, should be discounted at the firm's cost of capital to determine the present value of those cash flows.

The specific calculation of NPV is complex and involves multiple steps, including calculating the depreciation expense, tax savings from depreciation, operating cash inflows after taxes, and the terminal year cash flow considering the salvage value and recovery of net working capital. These cash flows are then discounted using the given discount rate to arrive at the present value. The NPV is found by subtracting the initial investment from the sum of these discounted cash flows.