ABC Company is analyzing whether a new contract proposal will be a good idea. Th
ID: 2744593 • Letter: A
Question
ABC Company is analyzing whether a new contract proposal will be a good idea. The relevant data is shown below. The net working capital will be paid in the same time period as the cost of the equipment and will be recovered at the end of the project. Remember to calculate the after-tax gain or loss of salvage as part of your terminal cash flow.
ABC Company Contract Analysis
Amount of Rock Salt per Year
25,000 Tons
Revenue per Ton
$ 130
Cost of Equipment
$ 1,500,000
Life
5
MACRS Class
5
Fixed Cost per year
$ 370,000
Var Cost/Ton
$ 95
Actual Salvage
$ 100,000
Change in NWC
$ 90,000
Required Return
11%
Tax Rate
35%
1. Find the annual cash flows.
ABC Company Contract Analysis
Amount of Rock Salt per Year
25,000 Tons
Revenue per Ton
$ 130
Cost of Equipment
$ 1,500,000
Life
5
MACRS Class
5
Fixed Cost per year
$ 370,000
Var Cost/Ton
$ 95
Actual Salvage
$ 100,000
Change in NWC
$ 90,000
Required Return
11%
Tax Rate
35%
Explanation / Answer
The annual cash flows:
Year 1 =Gross profit - Fixed cost - Depreciation = income before tax - tax = net income + depreciation = Cash flow
= (130-95) 25000 - 370000 - (1500000 * 20%) = 205000 (1-35%) + 300000 =$433250
Year 2 = (130-95) 25000 - 370000 - (1500000 * 32%) = 25000 (1-35%) + 480000 =$496250
Year 3 = (130-95) 25000 - 370000 - (1500000 * 19.20%) = 217000 (1-35%) + 288000 =$429050
Year 4 = (130-95) 25000 - 370000 - (1500000 * 11.52%) = 332200 (1-35%) + 172800 =$388730
Year 5 = (130-95) 25000 - 370000 - (1500000 * 11.52%) = 332200 (1-35%) + 172800 =$388730 + 100000 (salvage) + 90000 (reversal of working capital) = $578730
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