Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for

33

years and your cash flows from the contract would be

$ 5.24$5.24

million per year. Your upfront setup costs to be ready to produce the part would be

$ 7.82$7.82

million. Your discount rate for this contract is

7.6 %7.6%.

a. What does the NPV rule say you should​ do?

b. If you take the​ contract, what will be the change in the value of your​ firm?

Answer 1

(a)-Net Present Value (NPV) of the Project

Year	Annual Cash flow ($ in Million)	Present Value factor at 7.60%	Present Value of Annual Cash flow ($ in Million)
1	5.24	0.92937	4.87
2	5.24	0.86372	4.53
3	5.24	0.80272	4.21
TOTAL			13.60

Net Present Value (NPV) of the Project = Present value of annual cash inflows – Initial investment costs

= $13.60 Million - $7.82 Million

= $5.78 Million

“The Net Present Value (NPV) of the Opportunity will be $5.78 Million”

DECISION

“YES”. The project should be accepted, since the Net Present Value (NPV) of the Project is Positive $5.78 Million .

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.

(b)-Change in the value of the firm

Hence, the Change in the value of the firm will be $5.78 Million.