Net Present Value Analysis Champion Company is considering a contract that would

Question

Net Present Value Analysis
Champion Company is considering a contract that would require an expansion of its food processing capabilities. The contract covers five years. To provide the required products, Champion would have to purchase additional equipment for $80,000. Champion estimates the contract will provide annual net cash inflows (before taxes) of $35,000. For tax purposes, the equipment will be depreciated as follows:

Although salvage value is ignored in the tax depreciation calculations, Champion estimates the equipment will be sold for $10,000 after five years.

Assuming a 35% income tax rate and a 10% cutoff rate, compute the net present value of this contract proposal. Using net present value analysis, should Champion accept the contract?

  
Round answers to the nearest whole number. Use rounded answers for subsequent calculations.
Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers.

Should Champion accept the contract?

Select the most appropriate answer below.

Champion should accept the contract because there is a negative net present value.

Champion should not accept the contract because there is a positive net present value.

Champion should accept the contract because there is a positive net present value.

Champion should not accept the contract because there is a negative net present value

Year 1 $10,000 Year 2 20,000 Year 3 20,000 Year 4 20,000 Year 5 10,000

Explanation / Answer

Initial Investment = $80,000

Annual After Tax Cash Flow = 35,000 X (1-65%) = $22,750

Champion should accept the project because it has a positive net present value.

Amount PV Factor Present Value After-tax cash inflows for 5 years                           22,750 3.790786769                           86,240 Tax savings from depreciation Year 1                              3,500 0.909090909                              3,182 Year 2                              7,000 0.826446281                              5,785 Year 3                              7,000 0.751314801                              5,259 Year 4                              7,000 0.683013455                              4,781 Year 5                              3,500 0.620921323                              2,173 After-tax equipment sale proceeds                              6,500 0.620921323                              4,036 Total present value of future cash flows                        1,11,457 Investment required in equipment                          -80,000 Net positive (negative) present value                           31,457

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