Question

The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $210,000. Of this amount, $170,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $40,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

The contract will require an additional investment of $53,000 in working capital at the beginning of the first year and, of this amount, $33,000 will be returned to the Spartan Technology Company after six years.

The investment will produce $72,000 in income before depreciation and taxes for each of the six years. The corporation is in a 25 percent tax bracket and has a 14 percent cost of capital.

a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

b. Should the investment be undertaken?

• Yes

• No

Answer 1

Tax rate		25%
Calculation of annual depreciation
		100
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Total
Opening WDV		$             170,000	$           170,000	$             170,000	$           170,000	$               170,000	$           170,000
Dep Rate		20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Depreciation		$               34,000	$             54,400	$               32,640	$             19,584	$                 19,584	$                9,792	$     170,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6
Pretax operating cost saving		$               72,000	$             72,000	$               72,000	$             72,000	$                 72,000	$             72,000
Less: Depreciation		$               34,000	$             54,400	$               32,640	$             19,584	$                 19,584	$                9,792
Profit before tax		$               38,000	$             17,600	$               39,360	$             52,416	$                 52,416	$             62,208
Tax@25%		$                  9,500	$               4,400	$                  9,840	$             13,104	$                 13,104	$             15,552
Profit After Tax		$               28,500	$             13,200	$               29,520	$             39,312	$                 39,312	$             46,656
Add Depreciation		$               34,000	$             54,400	$               32,640	$             19,584	$                 19,584	$                9,792
Cash Profit after-tax		$               62,500	$             67,600	$               62,160	$             58,896	$                 58,896	$             56,448
Calculation of NPV
						14.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor	Present values
0		$            (210,000)	$            (53,000)		$          (263,000)	1.0000	$          (263,000)
1				$               62,500	$             62,500	0.8772	$             54,825
2				$               67,600	$             67,600	0.7695	$             52,016
3				$               62,160	$             62,160	0.6750	$             41,956
4				$               58,896	$             58,896	0.5921	$             34,871
5				$               58,896	$             58,896	0.5194	$             30,589
6		$               40,000	$             33,000	$               56,448	$           129,448	0.4556	$             58,975
					Net Present Value		$             10,231
As we can see that NPV is positive, hence project should be undertaken