The Diamond Freight Company has been offered a seven-year contract to haul munit
ID: 2416742 • Letter: T
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
$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 ($350,000). The new trucks would be depreciated over the seven year life.
Compute the net present value of this investment opportunity. (Round to the nearest dollar amount. Omit the "$" sign in your response.)
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
$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 ($350,000). The new trucks would be depreciated over the seven year life.
Required: (a)Compute the net present value of this investment opportunity. (Round to the nearest dollar amount. Omit the "$" sign in your response.)
(b) Compute the internal rate of return of this investment opportunity. (Round to two decimal places. Omit the "%" sign in your response.)Explanation / Answer
Net Initial outflow = $350000 - 16000 = $334000 * 0.7 (after tax) = $233,800
Depreciation for tax purpose = 350000 / 7 = $50000
Annual cash inflow = 105000 - 50000 = 55000 * 0.70 (after tax) + 50000 = $88500
PVIFA(16,7) = 4.039 & PVIF(16,7) = 0.354
Present Value at the 16% discount rate= 88500 * 4.039 + 18000 * 0.354 = $363823.50
Net present value = $363823.5 -$ 233800 = $130023.5
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