Question

After spending $10,900 on client development, you have just been offered a big production contract by a new client. The contract will add $193,000 to your revenues for each of the next five years and it will cost you $97.000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for $46,000 now. If you use it in the project, it will be worthless at the end of the production manager earns $78,000 per year. Since she is busy with ongoing projects, you are planning to hire an assistant at $42,000 per year to help with the expansion. You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project. Your company's tax rate is 35% and your discount rate is 14.6% What is the NPV of the contract? Note: Assume that the equipment is put into use in year 1. Calculate the free cash flows below. (Round to the nearest dollar) Year 0 Sales Cost of Goods Sold Gross Profit - Annual Cost Depreciation EBIT - Tax Incremental Earnings + Depreciation Incremental Working Capital Opportunity Cost - Capital Investment Incremental Free Cash Flow

do for all years

Answer 1

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Amount in $.

Calculation of NPV NPV Year 0 | Year 1 Sales 193,000 - Cost of Goods Sold -97,000 Gross Profit 96,000 - Annual Cost -42,000 - Depreciation -5,800 EBIT 48,200 - Tax -16,870 Incremental Earning 31,330 + Depreciation 5,800 - Incremental Working Capital - 10,000 - Opportunity Cost -46,000 - Capital Investment -29,000 + Tax Benefit on Loss of Asset at Year 5 Incremental Free Cash Flow -85,000 37,130 Discount Factor @ 14.6% 1 0.8726 Present Value of Incremental CF -85,000 32,400 Year 2 193,000 -97,000 96,000 -42,000 -8,700 45,300 -15,855 29,445 8,700 Year 3 193,000 -97,000 96,000 -42,000 -5,510 48,490 -16,972 31,519 5,510 Year 4 193,000 -97,000 96,000 -42,000 -3,480 50,520 -17,682 32,838 3,480 Year 5 193,000 -97,000 96,000 - 42,000 -3,480 50,520 -17,682 32,838 3,480 10,000 38,145 0.7614 29,045 37,029 0.6644 24,603 36,318 0.5798 21,056 508 46,826 0.5059 23,690) 45,793||

Notes & Assumption 5 Year MACRS Table for Calculation of Depreciation Recovery Year 5 Year 20% 2 30% 19% auw 12% 12% 5% Calculation of Tax Benefit at Loss of Equipment Asset at Terminal - Year 5 1450 Book Value at Year 5 =29000*5% Value at Year 5 Loss Tax Benefit @ 35% 1450 507.5 Discounting Factor @ 14.6% Discounting Factor = 1/(1+r)^n where, r = rate of interest and n= number of year

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