Vernon company has been offered a 7-year contract to supply a part for the milit
ID: 2371828 • Letter: V
Question
Vernon company has been offered a 7-year contract to supply a part for the military. After careful study, the company has developed the following estimated data relating to the contract:
Cost of equipment needed $300,000
Working capital needed $50,000
Annual cash receipts from the delivery of parts,
Less cash operating costs $70,000
Salvage value of equipment at termination of the contract $5,000
It is not expected that the contract would be extended beyond the initial contract period. The company’s discount rate is 10%.
Required:
Use the net present value method to determine if the contract should be accepted. Round all computations to the nearest dollar. (Please show all your works!)
Explanation / Answer
Fixed cost = $300,000 + $50,000 = $350,000
Yearly operating profit = $70,000
Future value of total profit= $70,000(1+0.9+0.9^2+0.9^4+0.9^4+0.9^5+0.9^6)
=$365,192
Future value of salvage value= $5000*0.9^5=$2,952
Total earning=$365,192+$2,952=$368,144
Net profit=$368,144-$350,000=$18,144
Yes the contract should be accepted
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