Question

Flag Bowman Corporation is considering an investment in special-purpose equipment to enable the company to obtain a four-year government contract for the manufacture of a special item. The equipment costs $276,000 and would have no salvage value when the contract expires at the end of the four years. Estimated annual operating results of the project are as follows:

Revenue from contract sales $ 302,000

Expenses other than depreciation $ 210,000 Depreciation (straight-line basis) 69,000 279,000

Increase in net income from contract work $23,000

b. Return on average investment?  (Round your percentage answer to 1 decimal place (i.e., 0.123 to be entered as 12.3).

c. Net present value of the proposal to undertake contract work, discounted at an annual rate of 5 percent. (Refer to the annuity table in Exhibit 26–4.) (Round your "PV factors" to 3 decimal places.)

Answer 1

(b): Return = Increase in net income from contract work = $23,000

Average investment = 276000/2 = 138,000.

Thus return on average investment = 23,000/138,000 = 16.7%

(c): NPV @ 5%: Here annual cash flow = net income + depreciation = 23000+69000 = 92000

Year	Cash flow	1+r	PV factor	PV
0	-                 276,000.00	1.05	1.000	-                      276,000.00
1-4	92,000.00		3.546	326,232.00
			NPV	50,232.00

Thus NPV = $50,232.0