After spending $10,500 on client-development, you have just been offered a big p
ID: 2725037 • Letter: A
Question
After spending $10,500 on client-development, you have just been offered a big production contract by a new client. The contract will add $198,000 to your revenues for each of the next five years and it will cost you $104,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for $31,000 now. If you use it in the project, it will be worthless at the end of the project. You will buy new equipment valued at $26,000 and use the 5-year MACRS schedule to depreciate it. It will be worthless at the end of the project. Your current production manager earns $81,000 per year. Since she is busy with ongoing projects, you are planning to hire an assistant at $37,000 per year to help with the expansion. You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project. Your company's tax rate is 35% and your discount rate is 14.6%, what is the NPV of the contract? P 9-27 (similar Calculate the free cash flows below: (Round to the nearest dollar.) Year 0 Year 1 Year 2 Salcs Cost of Goods Sold Gross Profit - Annual Cost EBIT - Tax Incremental Earnings + Depreciation Incremental Working Capital Opportunity Cost Capital Investment Incremental Free Cash Flow Year 3 Year 4 Year 5 Sales Cost of Goods Sold Gross Profit sl Annual Cost Depreciation EBIT - Tax Incremental Earnings + Depreciation - Incremental Working Capital S Opportunity CostExplanation / Answer
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Sales $198,000 $198,000 $198,000 $198,000 $198,000 - Cost of Goods Sold $104,000 $104,000 $104,000 $104,000 $104,000 Gross Profit $94,000 $94,000 $94,000 $94,000 $94,000 - Annual Cost $37,000 $37,000 $37,000 $37,000 $37,000 - Depreciation (Note 1) $5,200 $8,320 $4,992 $2,995 $2,995 EBIT $51,800 $48,680 $52,008 $54,005 $54,005 - Tax $18,130 $17,038 $18,203 $18,902 $18,902 Incremental Earnings $33,670 $31,642 $33,805 $35,103 $35,103 + Depreciation $5,200 $8,320 $4,992 $2,995 $2,995 - Incremental Working Capital $10,000 $0 $0 $0 $0 -$10,000 - Opportunity Cost $51,000 $0 $0 $0 $0 $0 - Capital Investment $26,000 $0 $0 $0 $0 $0 Incremental Free Cashflow (A) -$87,000 $28,470 $23,322 $28,813 $32,108 $42,108 PV Factor at 14.6% (B) 1.0000 0.8726 0.7614 0.6644 0.5798 0.5059 Present Value at 14.6% (A*B) -$87,000 $24,843 $17,758 $19,144 $18,615 $21,303 NPV = $14,664 Year Rate Depreciation a b = $26000 * a 1 20% $5,200.00 2 32% $8,320.00 3 19.20% $4,992.00 4 11.52% $2,995.20 5 11.52% $2,995.20