The Diamond Freight Company has been offered a seven-year contract to haul munit

Question

The Diamond Freight Company has been offered a seven-year contract to haul munitions for the government. Because this contract would represent new business, the company would have to purchase several new heavy-duty trucks at a cost of $350,000 if the contract were accepted. Other data relating to the contract follow:

  Annual net cash receipts (before taxes)
from the contract

  Salvage value of the trucks at termination
of the contract

The trucks will have a useful life of seven years. To raise money to assist in the purchase of the new trucks, the company will sell several old, fully depreciated trucks for a total selling price of $16,000. The company requires a 16% after-tax return on all equipment purchases. The tax rate is 30%. For tax purposes, the company computes depreciation deductions assuming zero salvage value and using straight-line depreciation on the full cost of the trucks ($350,000). The new trucks would be depreciated over the seven year life.

The Diamond Freight Company has been offered a seven-year contract to haul munitions for the government. Because this contract would represent new business, the company would have to purchase several new heavy-duty trucks at a cost of $350,000 if the contract were accepted. Other data relating to the contract follow:

Explanation / Answer

Hi,

Please find the answer as follows:

Annual Net Cash Flows after Taxes = 105000*(1-.30) = 73500

NPV = - 350000 + 16000*(1-.30) + 73500/(1+.16)^1 + 73500/(1+.16)^2 + 73500/(1+.16)^3 + 73500/(1+.16)^4 + 73500/(1+.16)^5 + 73500/(1+.16)^6 + 73500/(1+.16)^7 + 18000/(1+.16)^7 = -35597

IRR = 12.43%

Thanks.

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