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.

Required: (a) Compute the net present value of this investment opportunity. (Round to the nearest dollar amount. Omit the "$" sign in your response.) Net present value $

(b) Compute the internal rate of return of this investment opportunity. (Round to two decimal places. Omit the "%" sign in your response.) Internal rate of return % (c) Would you recommend that the contract be accepted?

Explanation / Answer

Answer: (a) & (b) Intial cost=New truck cost-cash received from the sale of the old trucks

=$350000-($16000*(1-0.30))

=$338800

Answer:(c) Yes, The contract would be accepted because NPV is positive and IRR is higher than cost of capital.

Required return 16% Year 0 1 2 3 4 5 6 7 Intial cost -338800 Annual net cash receipts before tax 105000 105000 105000 105000 105000 105000 105000 Less: Dep 50000 50000 50000 50000 50000 50000 50000 Annual net cash receipts after dep but before tax 55000 55000 55000 55000 55000 55000 55000 Less:tax @30% 16500 16500 16500 16500 16500 16500 16500 Annual net cash receipts after tax 38500 38500 38500 38500 38500 38500 38500 Add: Dep 50000 50000 50000 50000 50000 50000 50000 OCF 88500 88500 88500 88500 88500 88500 88500 Salvage value after tax 12600 Total cash flows -338800 88500 88500 88500 88500 88500 88500 101100 NPV 23071.29 IRR 18.25%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

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