P 8-8 (similar to) Question Help * Your factory has been offered a contract to p
ID: 2795439 • Letter: P
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P 8-8 (similar to) Question Help * 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 $5.03 million per year. Your upfront setup costs to be ready to produce the part would be $8.13 million. Your discount rate for this contract is 8.5% 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 $ million. (Round to two decimal places.)Explanation / Answer
a) Setup cost to produce parts = $8.13 million
Annual Cash flows from project = $5.03 million
Period of contract = 3 years
Disount rate for contract = 8.5%
NPV is sum of present value of all cash flows
Present value = cash flow/(1+r)n, where r is discount rate and n is number of years
NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3
NPV = -8.13 + 5.03/(1+0.085)1 + 5.03/(1+0.085)2 + 5.03/(1+0.085)3 = $4.72 million
NPV is greater tahn zero so firm should take the contract
b) If we take the project then firm value would increase by the value of NPV
So firm value will increase by $4.72 million
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