Question

The Diamond Freight Company has been offered a seven-year contract to haul munitions for the government. Because this contract would represent new business, the company would have to purchase several new heavy-duty trucks at a cost of $350,000 if the contract were accepted. Other data relating to the contract follow:

Annual net cash receipts (before taxes) from the contract	$105,000
Salvage value of the trucks at termination of the contract	$18,000

The trucks will have a useful life of seven years. To raise money to assist in the purchase of the new trucks, the company will sell several old, fully depreciated trucks for a total selling price of $16,000. The company requires a 16% after-tax return on all equipment purchases. The tax rate is 30%. For tax purposes, the company computes depreciation deductions assuming zero salvage value and using straight-line depreciation on the full cost of the trucks ($350,000). The new trucks would be depreciated over the seven year life.

Required:

(a)	Compute the net present value of this investment opportunity. (Round to the nearest dollar amount. Omit the "$" sign in your response.)

Net present value

$

(b)	Compute the internal rate of return of this investment opportunity. (Round to two decimal places. Omit the "%" sign in your response.)

Internal rate of return

%

(c)	Would you recommend that the contract be accepted?

Answer 1

a. Computaion of NPV
	Amount	Time	PVF @16%	PV
Present Value of Cash Outflow
Initial Investment on Truck	$350,000.00	0	1	$350,000.00
Salvage Value	-$18,000.00	7	0.354	-$6,372.00
Total PVCO (A)	$332,000.00			$343,628.00
Prevesnt Value of Cash Inflow
Annual Net Cash Receipt (1)	$105,000.00
Depreciation on Truck (350000/7)	-$50,000.00
Profit After Deprecation	$55,000.00
Tax @ 30% (2)	$16,500.00
Annual Cash flow after Tax (1-2)	$88,500.00	1-7	4.038	357363
NPV ( PVCI-PVCO)				$13,735.00
b. Computaion of IRR
			Discount Rate=16%		Discount Rate=18%
	Amount	Time	PVF @16%	PV	Pvf12%	PV
Present Value of Cash Outflow
Initial Investment on Truck	$350,000	0	1	$350,000	1	$350,000
Salvage Value	-$18,000	7	0.354	-$6,372	0.314	-$5,652
Total PVCO (A)	$332,000			$343,628		$344,348
Prevesnt Value of Cash Inflow
Annual Net Cash Receipt (1)	$105,000
Depreciation on Truck (350000/7)	-$50,000
Profit After Deprecation	$55,000
Tax @ 30% (2)	$16,500
Annual Cash flow after Tax (1-2)	$88,500	1-7	4.038	$357,363	3.812	$337,362
NPV ( PVCI-PVCO)				$13,735.00		-$6,986
IRR=     Lower discount rate            +	Lowere rate NPV                   *			(Higher Rate- lower Rate)
	Lowere rate NPV- Higher rate NPV
IRR=     16%            +	$13735                   *			(18%-16%)
	$13735-(-$6986)
IRR= 17.32%
C. IRR is 17.32% and required rate of retunr is 16%, IRR is greater than Required rate of Return and NPV at Required rate of return is also Positive . Hence Conctact may be accepted