Question

Net Present Value Analysis
Champion Company is considering a contract that would require an expansion of its food processing capabilities. The contract covers five years. To provide the required products, Champion would have to purchase additional equipment for $80,000. Champion estimates the contract will provide annual net cash inflows (before taxes) of $35,000. For tax purposes, the equipment will be depreciated as follows:

Year 1	$10,000
Year 2	20,000
Year 3	20,000
Year 4	20,000
Year 5	10,000

Although salvage value is ignored in the tax depreciation calculations, Champion estimates the equipment will be sold for $10,000 after five years.

Assuming a 35% income tax rate and a 10% cutoff rate, compute the net present value of this contract proposal. Using net present value analysis, should Champion accept the contract?

  
Round answers to the nearest whole number. Use rounded answers for subsequent calculations.
Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers.

After-Tax Cash Flow Analysis
	Amount	Present Value
After-tax cash inflows for 5 years	$Answer	$Answer
Tax savings from depreciation
Year 1	Answer	Answer
Year 2	Answer	Answer
Year 3	Answer	Answer
Year 4	Answer	Answer
Year 5	Answer	Answer
After-tax equipment sale proceeds	Answer	Answer
Total present value of future cash flows		Answer
Investment required in equipment		Answer
Net positive (negative) present value		$Answer

Should Champion accept the contract?

Select the most appropriate answer below.

Champion should accept the contract because there is a negative net present value.

Champion should not accept the contract because there is a positive net present value.

Champion should accept the contract because there is a positive net present value.

Champion should not accept the contract because there is a negative net present value

Answer 1

Initial Investment = $80,000

Annual After Tax Cash Flow = 35,000 X (1-65%) = $22,750

	Amount	PV Factor	Present Value
After-tax cash inflows for 5 years	22,750	3.790786769	86,240
Tax savings from depreciation
Year 1	3,500	0.909090909	3,182
Year 2	7,000	0.826446281	5,785
Year 3	7,000	0.751314801	5,259
Year 4	7,000	0.683013455	4,781
Year 5	3,500	0.620921323	2,173
After-tax equipment sale proceeds	6,500	0.620921323	4,036
Total present value of future cash flows			1,11,457
Investment required in equipment			-80,000
Net positive (negative) present value			31,457

Champion should accept the project because it has a positive net present value.