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

$ 4.92 million per year. Your upfront setup costs to be ready to produce the part would be $8.07 million. Your discount rate for this contract is 8.4%.

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?

Answer 1

a.Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=4.92[1-(1.084)^-3]/0.084

=4.92*2.558609313

=$12.59 million

NPV=Present value of inflows-Present value of outflows

=$12.59 million-$8.07 million

=$4.52 million(Approx)

Hence since NPV is positive;contract should be accepted.

b.Change in value=Increase in value by =$4.52 million(Approx).