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 $160.000. Of this amount. $135,000 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 $25.000. 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 $46,000 in working capital at the beginning of the first year and, of this amount. $26.000 will be returned to the Spartan Technology Company after six years. The investment will produce $49,000 in income before depreciation and taxes for each of the six years. The corporation is in a 25 percent tax bracket and has a 9 percent cost of capital. a. Calculate the net present value. (Do not round Intermedlate calculations and round your answer to 2 decimal places.) Net present value b. Should the investment be undertaken? O Yes O NO

Answer 1

5-year MACRS schedule:

2 Formula BVn-1 - Dn 135000 Year (n) Book value (BV) Depreciation rate ('r) Depreciation (D) 108000 20.00% 27000 64800 32.00% 432001 38880 19.20% 25920 23328 11.52% 15552 7776 11.52% 15552 5.76% 7776 BVO*r

NPV calculation:

0 160000 49000 49000 49000 49000 49000 49000 27000 43200 259201 15552 15552 7776 43500 47550 43230 40638 40638 Formula Year (n) Initial investment (11) EBITDA From the depreciation schedule Depreciation (D) EBITDA*(1-Tax rate)+(D*Tax rate) Operating cash flow (OCF) Increase in NWC Salvage value of non- depreciable investment (SV) OCF - || - Inc. in NWC + SV Free cash flow (FCF) 1/(1+9%)an Discount factor @ 9% FCF*Discount factor PV of FCF Sum of all PVS NPV 38694 26000 - 46000 25000 89694 -206000 1.000 -2060001 15994.13 43500 0.9171 39908.26 47550 0.842 40021.88 43230 0.772 33381.49 40638 0.708 28788.98 406381 0.650 26411.91 0.596 5 3481.60

a). NPV = 15,994.13

b). Yes, the investment should be undertaken as it has a positive NPV.

2 Formula BVn-1 - Dn 135000 Year (n) Book value (BV) Depreciation rate ('r) Depreciation (D) 108000 20.00% 27000 64800 32.00% 432001 38880 19.20% 25920 23328 11.52% 15552 7776 11.52% 15552 5.76% 7776 BVO*r

1 2 160000 49000 49000 27000 49000 43200 49000 25920 49000 15552 49000 7776 15552 435001 47550 432301 40638 40638 Formula Year (n) Initial investment (11) EBITDA Depreciation (D) IEBITDA*(1-Tax rate)+(D*Tax rate) Operating cash flow (OCF) Increase in NWC Salvage value of non-depreciable investment (SV) OCF - |- Inc. in NWC + SV Free cash flow (FCF) 1/(1+9%)^n Discount factor @ 9% FCF*Discount factor PV of FCF Sum of all PVS NPV 38694 26000 -46000 -206000 1.000 -206000 15994.13 43500 47550 432301 0.917 0.842 0.772 39908.2640021.8833381.49 40638 0.708 28788.98 40638 0.650 26411.91 25000 89694 0.596 53481.60