Question

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 $ 4.82 million per year. Your upfront setup costs to be ready to produce the part would be $ 7.78 million. Your discount rate for this contract is 7.9 %. 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. What does the NPV rule say you should​ do?

The NPV of the project is

​$nothing

million.  ​(Round to two decimal​ places.)

What should you​ do?  ​(Select the best choice​ below.)

A.The NPV rule says that you should accept the contract because the

NPV less than 0NPV<0.

B.The NPV rule says that you should not accept the contract because the

NPV less than 0NPV<0.

C.The NPV rule says that you should accept the contract because the

NPV greater than 0NPV>0.

D.The NPV rule says that you should not accept the contract because the

NPV greater than 0NPV>0.

b. If you take the​ contract, what will be the change in the value of your​ firm?

If you take the​ contract, the value added to the firm will be

​$nothing

million.  ​(Round to two decimal​ places.)

Answer 1

Calculation of NPV of the Project:

Initial Outlay of the Contract in Year 0 = $7,780,000

Cash Inflows in Year 1, 2 and 3 = $4,820,000

Present value of Cash inflows = [$4,820,000 / (1+7.9%)^1] + [$4,820,000 / (1+7.9%)^2] + [$4,820,000 / (1+7.9%)^3]

= [$4,820,000 / 1.079] + [$4,820,000 / 1.164241] + [$4,820,000 / 1.256216]

= 4,469,099.166 + 4,140,036.298 + 3,836,919.646

= $12,444,055.11

NPV of the Contract = Present value of future cash inflows - Initial Outlay of the contract

= $12,444,055.11 - $ 7,780,000

= $4,644,055.11

Therefore, NPV of the Contract = $4,644,055.11

Question a:

What does NPV rule say you should do

Option C is correct

The NPV rule says that you should accept the contract because the NPV is greater than 0 NPV > 0

Question b:

If you take the contract, the value added to the firm is $4,644,055.11 (i.e. NPV of the contract)