A company generates perpetual revenues averaging $20 million per year. On average, raw materials are 60%...

A company generates perpetual revenues averaging $20 million per year. On average, raw materials are 60% of revenues. There are no other operating costs. (Ignore taxes.) A vendor offers to supply all raw materials for a five-year fixed price contract of $12 million per year. Subsequently, your company will revert to variable prices for raw materials. The company cost of capital is 10% and the cost of debt is 6%

a. Calculate the value of the company with and without the fixed price contract.

b. Provide a financial explanation why there is or is not a difference between the two values. You need to discuss the finance principles.

c. What fixed price will make the company indifferent between accepting the contract and staying with existing situation?

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Expert Solution

ANSWER IN THE IMAGE. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

jeff jeffy answered 1 year ago

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