Good Contracting Inc. is analyzing whether a new contract proposal will be a goo
ID: 2744840 • Letter: G
Question
Good Contracting Inc. 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.
Good Contracting Inc. 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%
Find the annual cash flows.
Annual Cash Flows for Good Contracting Inc.
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial Outlay
Unit Sales
Sales
Variable Costs
Fixed Costs
Depreciation
Taxable Cash Flows
Taxes
Add: Depreciation
Annual After-Tax Cash Flow
Terminal Cash Flow
Total Annual Cash Flows
Good Contracting Inc. 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
Initial investment = cost of asset + net working capital
= 1,500,000 +90,000
= 1,590,000
Expected salvage value = cost of asset x macrs rate year 6
= 1500,000 x 5.76%
= 86400
Net salvage value = actual salvage value – (actual salvage value – expected salvage value) x tax rate
= 100,000 – (100,000-86400) x0.35
=95,240
Terminal cash flow = net salvage value + working capital recovered
= 95,240 +90,000
= 185,240
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial outlay
-1590000
Unit sales
25000
25000
25000
25000
25000
Sales
3250000
3250000
3250000
3250000
3250000
variable costs
-2375000
-2375000
-2375000
-2375000
-2375000
fixed costs
-370000
-370000
-370000
-370000
-370000
Depreciation
-300000
-480000
-288000
-172800
-172800
Taxable cash flow
205000
25000
217000
332200
332200
Taxes
-71750
-8750
-75950
-116270
-116270
Add: Depreciation
300000
480000
288000
172800
172800
Annual After tax cash flow
433250
496250
429050
388730
388730
Terminal cash flow
185240
Total annual cash flows
-1590000
433250
496250
429050
388730
573970
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial outlay
-1590000
Unit sales
25000
25000
25000
25000
25000
Sales
3250000
3250000
3250000
3250000
3250000
variable costs
-2375000
-2375000
-2375000
-2375000
-2375000
fixed costs
-370000
-370000
-370000
-370000
-370000
Depreciation
-300000
-480000
-288000
-172800
-172800
Taxable cash flow
205000
25000
217000
332200
332200
Taxes
-71750
-8750
-75950
-116270
-116270
Add: Depreciation
300000
480000
288000
172800
172800
Annual After tax cash flow
433250
496250
429050
388730
388730
Terminal cash flow
185240
Total annual cash flows
-1590000
433250
496250
429050
388730
573970
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