Question

Pacific Marine services has been offered a contract to provide highly classified services to the U.S. Navy. The contract is for 8 years. The projected costs and revenues for the project are given below:

Cost of new equipment                                                                                                       $600,000

Working capital needed                                                                                                          90,000

Net annual Cash receipts                                                                                                         85,000

Equipment rebuilding cost

Half way thru the contract                                                                                                     130,000

Salvage value of equipment

In 8 years                                                                                                                                 30,000

Pacific Marine services cost of capital is 12 percent. Complete an analysis to determine whether or not this contract should be accepted by utilizing the Net Present Value Method. Should the contract be accepted? Explain, Show all your calculations in good form.

Answer 1

Initial Investment
Cost of new equipment	600,000.00
Working Capital	90,000.00
Total Invistment	690,000.00

Present Value of Inflows
	Inflows	Outflow	Net Inflows	Ptresent Value Factor	Present Value
1	85,000		85,000	0.892857	75,893
2	85,000		85,000	0.797194	67,761
3	85,000		85,000	0.711780	60,501
4	85,000	130,000	(45,000)	0.635518	(28,598)
5	85,000		85,000	0.567427	48,231
6	85,000		85,000	0.506631	43,064
7	85,000		85,000	0.452349	38,450
8	85,000		85,000	0.403883	34,330
8	30,000		30,000	0.403883	12,116
8	90,000		90,000	0.403883	36,349
					388,098

Present Value of Inflows	388,098.02
Less: Initial Investment	690,000.00
Net Present Value	(301,901.98)

Since we have negative NPV, the project will not be accepted.

Please note that it has been Assumed that the Equipment rebuilding cost will be incurred at the end of year 4.

For Your Understanding:

Working Capital is considered as outflow with Initial Investment and shown as inflow at the end of year 8. So effectively the time value of Working capital is captured in the question.

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