The Diamond Freight Company has been offered a seven-year contract to haul munit
ID: 2416743 • 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
a) Cash flow after tax = Net cash flow-tax+depreciation
=105,000-31,500+50,000
= $123,500
DCFAT = CFAT*PV Factor
= 123,500*4.039
= $498,816.5
Net Present Value = DCFAT-Initial investment
= 498,816.5-350,000
= $148,816.5
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