The Spartan Technology Company has a proposed contract with the Digital Systems
ID: 2744754 • Letter: T
Question
The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $200,000. Of this amount, $170,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $30,000 after taxes. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. The contract will require an additional investment of $50,000 in working capital at the beginning of the first year and, of this amount, $30,000 will be returned to the Spartan Technology Company after six years. The investment will produce $62,000 in income before depreciation and taxes for each of the six years. The corporation is in a 30 percent tax bracket and has a 5 percent cost of capital. a. Calculate the net present value.
Explanation / Answer
Initial outflow on the proposed contract =$200,000.
Depreciable investment=$170,000.
Using MACRS mid quarter convention first quarter:
The rate is multiplied with the book value of the asset every year.
Cash inflow for the year6 is arrived by adding cash inflow is Profit after tax+working capital plouged back+resale value of non depreciable property.
=$41,757.80+30000+30000
=$101,757.80.
Formula for NPV is Present value of cash inflows-Present value of cash outflows.
Formula for present value factor is 1/(1+i)^n
Here i is the required rate of return or cost of capital and n is the number of year.
As the NPV is Positive i.e., $58,751.56, the contract should be taken up.
Year Depreciation rates Depreciation 0 1 35% 59500 2 26.00% 44200 3 15.60% 26520 4 11.01% 18717 5 11.01% 18717 6 1.38% 2346Related Questions
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