Question

Berger’s Lawn Maintenance Inc. is considering accepting 20-year property maintenance contract from the City of Kingston. The contract would require Berger’s to acquire new landscaping equipment, including a new trencher and excavator machine, amounting to a total purchase cost of $500,000 plus installation costs of $50,000. Other data relating to the contract are as follows: Annual incremental revenues from the contract $200,000 Annual maintenance cost for the new equipment $80,000 Additional maintenance costs at the end of year 10 $300,000 Salvage value of the equipment at termination of the contract $20,000 If the contract was accepted, several old, fully depreciated pieces of equipment would be sold at a total price of $30,000 upon signing the contract. These funds would be used to help purchase the new equipment. For tax purposes, the company computes CCA deductions using the maximum rate of 20%. The company requires an 11% after-tax return on all equipment purchases. The tax rate is 30%.

Required: Compute the net present value of this investment opportunity. Round all dollar amounts to the nearest whole dollar. Would you recommend that the contract be accepted?

Answer 1

	Calculation of Present Value of Cash Inflows
Year	Cash Inflow	Depreciation	Net Income	Tax @ 30%	Net after Tax Income	Net Income before Depreciation	PVF @11%	Present Value
1	120000	104000	16000	4800	11200	115200	0.9091	104727.17
2	120000	124800	-4800	-1440	-3360	121440	0.8264	100363.63
3	120000	87360	32640	9792	22848	110208	0.7513	82800.90
4	120000	61152	58848	17654	41194	102346	0.6830	69903.42
5	120000	42806	77194	23158	54036	96842	0.6209	60131.08
6	120000	29964	90036	27011	63025	92989	0.5645	52489.70
7	120000	20975	99025	29707	69317	90293	0.5132	46334.34
8	120000	14683	105317	31595	73722	88405	0.4665	41241.45
9	120000	10278	109722	32917	76806	87083	0.4241	36931.84
10	120000	7194	112806	33842	78964	86158	0.3855	33217.76
10	Additional Maintenance Cost			-300000	0.3855	-115662.96
11	120000	5036	114964	34489	80475	85511	0.3505	29971.03
12	120000	3525	116475	34942	81532	85058	0.3186	27101.97
13	120000	2468	117532	35260	82273	84740	0.2897	24546.24
14	120000	1727	118273	35482	82791	84518	0.2633	22256.18
15	120000	1209	118791	35637	83154	84363	0.2394	20195.60
16	120000	846	119154	35746	83408	84254	0.2176	18336.10
17	120000	592	119408	35822	83585	84178	0.1978	16654.12
18	120000	415	119585	35876	83710	84124	0.1799	15130.52
19	120000	290	119710	35913	83797	84087	0.1635	13748.91
20	120000	203	119797	35939	83858	84061	0.1486	12495.12
20	After Tax profit on sale of Equipment		13668	0.1486	2031.66
				Total Present Value of Inflows		714945.77
	Initial Investment
	Purchase Cost				500000
	Installation Cost				50000
	Prosceeds from Sale of old equipment		-30000
	Net Costs					520000		520000
					Net Present Value		194945.77

Depreciation Schedule
Year	Opening Value	Depreciation @ 20%	Closing Value
1	520000	104000	416000
2	416000	124800	291200
3	291200	87360	203840
4	203840	61152	142688
5	142688	42806	99882
6	99882	29964	69917
7	69917	20975	48942
8	48942	14683	34259
9	34259	10278	23982
10	23982	7194	16787
11	16787	5036	11751
12	11751	3525	8226
13	8226	2468	5758
14	5758	1727	4031
15	4031	1209	2821
16	2821	846	1975
17	1975	592	1382
18	1382	415	968
19	968	290	677
20	677	203	474
	Salvage Vale =	20000
	Profit		19526
	Less Tax @ 30%	5857.742
	Net Profit After Tax	13668

As the Net Present Value from the project is positive, the project is recommended to be accepted.