Dog
Up! Franks is looking at a new sausage system with an installed cost of
$460,000. This cost will be depreciated straightline to zero over the
project’s fiveyear life, at the end of which the sausage system can be
scrapped for $66,000. The sausage system will save the firm $230,000 per
year in pretax operating costs, and the system requires an initial
investment in net working capital of $25,000. If the tax rate is 30
percent and the discount rate is 8 percent, what is the NPV of this
project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Explanation:
First we will calculate the annual depreciation of the new equipment. It will be: 
Annual depreciation = $460,000/5 
Annual depreciation = $92,000 
Now,
we calculate the aftertax salvage value. The aftertax salvage value is
the market price minus (or plus) the taxes on the sale of the equipment,
so:

Very
often the book value of the equipment is zero as it is in this case. If
the book value is zero, the equation for the aftertax salvage value
becomes:

Aftertax salvage value = MV + (0 − MV)T 
Aftertax salvage value = MV(1 − T) 
We
will use this equation to find the aftertax salvage value since we know
the book value is zero. So, the aftertax salvage value is:

Aftertax salvage value = $66,000(1 − 0.30) 
Aftertax salvage value = $46,200 
Using the tax shield approach, we find the OCF for the project is: 
OCF = $230,000(1 − 0.30) + 0.30($92,000) 
OCF = $188,600 
Now
we can find the project NPV. Notice we include the NWC in the initial
cash outlay. The recovery of the NWC occurs in Year 5, along with the
aftertax salvage value.

NPV = −$460,000 − 25,000 + $188,600(PVIFA_{8}_{%,5}) + [($46,200 + 25,000) / 1.08^{5}] 
NPV = $316,482.64 