Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $4.98 million per year. Your upfront setup costs to be ready to produce the part would be $7.77 million. Your discount rate for this contract is 7.6 %
a. What does the NPV rule say you should do?
b. If you take the contract, what will be the change in the value of your firm?
a.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate
=4.98[1-(1.076)^-3]/0.076
=4.98* 2.59581131
=$12.93 million
NPV=Present value of inflows-Present value of outflows
=$12.93 million-$7.77 million
=$5.16 million
Hence since NPV is positive;contract should be accepted.
b.Change in value=Increase in value of firm by =$5.16 million(Approx).
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