The Spartan Technology Company has a proposed contract with the Digital Systems
ID: 2776269 • 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 $260,000. Of this amount, $210,000 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 $50,000. 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 $56,000 in working capital at the beginning of the first year and, of this amount, $36,000 will be returned to the Spartan Technology Company after six years.
The investment will produce $81,000 in income before depreciation and taxes for each of the six years. The corporation is in a 30 percent tax bracket and has a 6 percent cost of capital.
a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)
Explanation / Answer
Cash flow in Year 0 = - initial investment in land and equipment - additional investment in working capital
Cash flow in Year 0 = - 260000 - 56000
Cash flow in Year 0 = - 316000
Cash flow in Year 1 = 81000*(1-30%) + 210000*20%*30%
Cash flow in Year 1 = 69300
Cash flow in Year 2 = 81000*(1-30%) + 210000*32%*30%
Cash flow in Year 2 = 76860
Cash flow in Year 3 = 81000*(1-30%) + 210000*19.2%*30%
Cash flow in Year 3 = 68796
Cash flow in Year 4 = 81000*(1-30%) + 210000*11.52%*30%
Cash flow in Year 4= 63957.60
Cash flow in Year 5 = 81000*(1-30%) + 210000*11.52%*30%
Cash flow in Year 5= 63957.60
Cash flow in Year 6 = 81000*(1-30%) + 210000*5.76%*30% + 36000 + 50000
Cash flow in Year 6 = 146,328.80
Net present value = -316000 + 69300/1.06 + 76860/1.06^2 + 68796/1.06^3+ 63957.60/1.06^4+ 63957.60/1.06^5 + 146328.80/1.06^6
Net present value = 77,154.21
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