Your factory has been offered a contract to produce a part for a new printer. Th

Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $4.81 million per year. Your upfront setup costs to be ready to produce the part would be $8.11 million. Your discount rate for this contract is 7.5%. a. What does the NPV rule say you should do? b. If you take the contract, what will be the change in the value of your firm? a. What does the NPV rule say you should do? The NPV of the project is Smillion. (Round to two decimal places.)

Explanation / Answer

Cahflows from the contrct = 4.81 million

Setup cost = 8.11 million

discount rate = 7.5%

NPV = -8110000 + 4810000/(1.075) + 4810000/((1.075)2 ) + 4810000/((1.075)3 )

= -8110000 + 4474418.60 + 4162249.86 + 3871860.34

= 4398528.81

NPV >0, hence accept the contract

b. By accepting the contract, firm value increases by NPV,

so value increases by 4398528.81

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