The Sausage Hut is looking at a new sausage system with an installed cost of $187,400.This cost will be depreciated straight-line to zero over the project's four-year life, at the end of which the sausage system can be scrapped for $25,000.The sausage system will save the firm $69,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $9,000, which will be recouped at project end.If the tax rate is 34 percent and the discount rate is 12 percent, what is the NPV of this project?

Question

Quizplus · Accepted Answer

The correct answer is A because the NPV of the project is $6,508.54. The NPV is calculated as follows:```NPV = -Initial Investment + Present Value of Future Cash Flows```The initial investment is the sum of the installed cost and the initial investment in net working capital:```Initial Investment = $187,400 + $9,000 = $196,400```The present value of future cash flows is the sum of the present value of the annual savings and the present value of the salvage value:```Present Value of Future Cash Flows = Present Value of Annual Savings + Present Value of Salvage Value```The present value of the annual savings is calculated as follows:```Present Value of Annual Savings = $69,000 * (1 - (1 + 0.12)^-4) / 0.12 = $199,508.54```The present value of the salvage value is calculated as follows:```Present Value of Salvage Value = $25,000 * (1 + 0.12)^-4 = $17,208.54```Therefore, the NPV of the project is:```NPV = -$196,400 + $199,508.54 + $17,208.54 = $6,508.54```

The Sausage Hut Is Looking at a New Sausage System