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

$105,000

  Salvage value of the trucks at termination
of the contract

$18,000

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

Depreciaton =( Cost-Salvage Value )/Life = (350000-0)/7 =           50,000 Year Receipts Depreciation Net Cash Before Tax Tax Net Cash After Tax( Incl Depreciation) 1         105,000           50,000                    55,000     38,500                66,500 2         105,000           50,000                    55,000     38,500                66,500 3         105,000           50,000                    55,000     38,500                66,500 4         105,000           50,000                    55,000     38,500                66,500 5         105,000           50,000                    55,000     38,500                66,500 6         105,000           50,000                    55,000     38,500                66,500 7         105,000           50,000                    55,000     38,500                66,500 Caluclation of Net Present Value Since Cash flowas are after tax, Cost of Capital is also after tax = 16% Year Cash Flow Present Vale Factor @ 16% Present Value 0       (350,000)               1.00                (350,000) 1           66,500               0.86                    57,328 2           66,500               0.74                    49,420 3           66,500               0.64                    42,604 4           66,500               0.55                    36,727 5           66,500               0.48                    31,662 6           66,500               0.41                    27,294 7           66,500               0.35                    23,530 NPV                  (81,435) Caluclation of IRR IRR is the Rate at which NPV is Zero Year Cash Flow Present Vale Factor @ 7.7% Present Value 0       (350,000)               1.00                (350,000) 1           66,500               0.93                    61,746 2           66,500               0.86                    57,331 3           66,500               0.80                    53,232 4           66,500               0.74                    49,426 5           66,500               0.69                    45,893 6           66,500               0.64                    42,612 7           66,500               0.59                    39,565                       (195) IRR Is 7.7% (Approxmately)

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.