Question

The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $370,000. Of this amount, $250,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $120,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

The contract will require an additional investment of $58,000 in working capital at the beginning of the first year and, of this amount, $38,000 will be returned to the Spartan Technology Company after six years.

The investment will produce $90,000 in income before depreciation and taxes for each of the six years. The corporation is in a 25 percent tax bracket and has a 5 percent cost of capital.

a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

b. Should the investment be undertaken?

• Yes

• No

Answer 1

Tax rate		25%
Calculation of annual depreciation
		100
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Total
Opening WDV		250000.00	250000.00	250000.00	250000.00	250000.00	250000.00
Dep Rate		20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Depreciation		50000.00	80000.00	48000.00	28800.00	28800.00	14400.00	250000.00
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6
Pretax operating cost saving		90000	90000	90000	90000	90000	90000
Less: Depreciation		50000.00	80000.00	48000.00	28800.00	28800.00	14400.00
Profit before tax		40000.00	10000.00	42000.00	61200.00	61200.00	75600.00
Tax@25%		10000	2500	10500	15300	15300	18900
Profit After Tax		30000.00	7500.00	31500.00	45900.00	45900.00	56700.00
Add Depreciation		50000.00	80000.00	48000.00	28800.00	28800.00	14400.00
Cash Profit after-tax		80000.00	87500.00	79500.00	74700.00	74700.00	71100.00
A. Calculation of NPV
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor @5%	Present values
0		-370000	-58000		-428000	1	-428000
1				80000.00	80000	0.952	76160
2				87500.00	87500	0.907	79362.5
3				79500.00	79500	0.864	68688
4				74700.00	74700	0.823	61478.1
5				74700.00	74700	0.784	58564.8
6		120000	38000	71100.00	229100	0.746	170908.6
					Net Present Value		87162
B. As we can see that NPV is positive, hence project should be undertaken