Question

García and Martinez manufacture widgets and currently have $12 million in taxable income. The company recently spent $250,000 to put together a bid for a government contract, and this morning they were notified that they won the contract. The contract requires the firm to provide 70,000 widgets a year for 6 years, and the government will pay $25 for each widget. To satisfy the new contract, García and Martinez estimate they will need an additional $6,000,000 worth of machinery. The machinery costs $150,000 a year to operate and maintain. García and Martinez plan to depreciate the machinery over the 6 years to the expected salvage value of $700,000. The company will immediately need to invest $500,000 in inventory, an amount that will be maintained over the six years. Similarly, the company must hold an additional $50,000 in cash over the project’s life. Both investments will be recovered when the project is completed. The marginal cost of producing a widget is $5.00 and the cost of capital is 16%.

1. Calculate the net capital spending for each period 0-6

2. Calculate the change in net working capital for each period 0-6

3. Calculate the operating cash flow for each period 0-6.

Calculate the project’s NPV

Answer 1

Use spreadsheet for the ease in computations. Enter values and formulas in the spreadsheet as shown in the image below.

The obtained result is provided below.