Suppose that Ace Electric has been offered a contract to supply a regional merch

Question

Suppose that Ace Electric has been offered a contract to supply a regional merchandising company with a line of food blenders to be sold under the company's private brand name. Ace Electric's treasurer estimate that the initial investment in new equipment required producing the blenders would be $1,000,000. The equipment would be depreciated over five years with zero estimated salvage value at the end of the five years. Based on the contract specifications, the treasurer estimates that incremental revenues would be S800.000 per year. The incremental costs if the contract wore accepted would be $450,000 per year. These include cash outlays for direct labor and materials, transportation, utilities, buildings rent. and additional overhead. The firm's marginal income tax rate is 40% and its cost of capital is 12%.. Should Ace SiCCQPL.Vm offer and why?

Explanation / Answer

Now we will do Net Present Value Analysis

As we can see that the NPV of the project is positive hence Ace should accept the offer.

Year Revenue Total Costs Incremental Revenue Depreciation Net of Dep. Net of Tax Net Cash Flow 1 $ 8,00,000.00 $ 4,50,000.00 $              3,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $ 90,000.00 $ 2,90,000.00 2 $ 8,00,000.00 $ 4,50,000.00 $              3,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $ 90,000.00 $ 2,90,000.00 3 $ 8,00,000.00 $ 4,50,000.00 $              3,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $ 90,000.00 $ 2,90,000.00 4 $ 8,00,000.00 $ 4,50,000.00 $              3,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $ 90,000.00 $ 2,90,000.00 5 $ 8,00,000.00 $ 4,50,000.00 $              3,50,000.00 $ 2,00,000.00 $ 1,50,000.00 $ 90,000.00 $ 2,90,000.00

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