Question

After spending $ 9,000 on? client-development, you have just been offered a big production contract by a new client. The contract will add $ 196,000 to your revenues for each of the next five years and it will cost you $ 101,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully? depreciated, but could be sold for $ 51,000 now. If you use it in the? project, it will be worthless at the end of the project. You will buy new equipment valued at $ 26,000 and use the? 5-year MACRS schedule to depreciate it. It will be worthless at the end of the project. Your current production manager earns $ 84,000 per year. Since she is busy with ongoing? projects, you are planning to hire an assistant at $ 41,000 per year to help with the expansion. You will have to immediately increase your inventory from $ 20,000 to $ 30,000. It will return to $ 20,000 at the end of the project. Your? company's tax rate is 35 % and your discount rate is 14.9 %. What is the NPV of the? contract?

Note?: Assume that the equipment is put into use in year 1.

	year 0
sales	$
-cogs	$
gross profit	$
- annual cost	$
- depreciation	$
EBIT	$
- tax	$
Incrmenental earnings	$
+ depreciation	$
-incrmental working capital	$
- opportunity cost	$
- capital investment	$
incremental free cash flow	$

Answer 1

Tax rate	35%
	Year-1	Year-2	Year-3	Year-4	Year-5
Sale	196,000	196,000	196,000	196,000	196,000
Less: Operating Cost	101,000	101,000	101,000	101,000	101,000
Contribution	95,000	95,000	95,000	95,000	95,000
Less: Fixed Cost	41,000	41,000	41,000	41,000	41,000
Less: Depreciation as per table given below	5,200	8,320	4,992	2,995	2,995
Profit before tax	48,800	45,680	49,008	51,005	51,005
Tax	17,080	15,988	17,153	17,852	17,852
Profit After Tax	31,720	29,692	31,855	33,153	33,153
Add Depreciation	5,200	8,320	4,992	2,995	2,995
Cash Profit After tax	36,920	38,012	36,847	36,148	36,148
Cost of macine		26,000
Depreciation		24,502
WDV		1,498
Sale price		-
Profit/(Loss)		(1,498)
Tax		(524)
Sale price after tax		524
Depreciation	Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost	26,000	26,000	26,000	26,000	26,000
Dep Rate	20.00%	32.00%	19.20%	11.52%	11.52%
Deprecaition	5,200	8,320	4,992	2,995	2,995	24,502
Calculation of NPV
					14.90%
Year	Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0	(77,000)	(10,000)		(87,000)	1.000	(87,000)
1			36,920	36,920	0.870	32,132
2			38,012	38,012	0.757	28,793
3			36,847	36,847	0.659	24,291
4			36,148	36,148	0.574	20,740
5	524	10,000	36,148	46,672	0.499	23,306
				Net Present Value		42,261