The Spartan Technology Company has a proposed contract with the Digital Systems

Question

The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $160,000. Of this amount, $145,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $15,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. The contract will require an additional investment of $47,000 in working capital at the beginning of the first year and, of this amount, $27,000 will be returned to the Spartan Technology Company after six years. The investment will produce $52,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 8 percent cost of capital. a. Calculate the net present value.(Do not round intermediate calculations and round your answer to 2 decimal places.)

Explanation / Answer

Computation of Present Value of Cash Inflow Year 1 2 3 4 5 6 EBDT $52,000 $52,000 $52,000 $52,000 $52,000 $52,000 Less: Depreciation $29,000 $46,400 $27,840 $16,675 $16,675 $8,410 Earnings bef Tax $23,000 $5,600 $24,160 $35,325 $35,325 $43,590 Less: Tax @ 40% $9,200 $2,240 $9,664 $14,130 $14,130 $17,436 Earnings after tax $13,800 $3,360 $14,496 $21,195 $21,195 $26,154 Add: Depreciation $29,000 $46,400 $27,840 $16,675 $16,675 $8,410 Annual CFAT $42,800 $49,760 $42,336 $37,870 $37,870 $34,564 Sale of Non Dep Asset $15,000 Recovery of Working Capital $27,000 Total Cash inflow $42,800 $49,760 $42,336 $37,870 $37,870 $76,564 Add: Recovery of Working capital $25,000 Total (Annual cash flow) $35,600 $38,960 $35,376 $33,220 $33,220 $106,624 PVAF @8% 0.9259 0.9259 0.9259 0.9259 0.9259 0.9259 Present Value of Cash Inflow $32,963 $36,074 $32,756 $30,759 $30,759 $98,726 Total Present Value of Cash inflow in 6 Year=$262037 Computation of Depreciation as per MACRS Computation of NPV Year Depreciation Base % of Depreciation Annual Depreciation Intial Investment in Land & Equipment $160,000 1 $145,000 0.2 $29,000 Addition Investment in Working Capital $47,000 2 $145,000 0.32 $46,400 Total Cash Outlow (b) $207,000 3 $145,000 0.192 $27,840 Present Value of Cash Inflow (a) $262,037 4 $145,000 0.115 $16,675 Net Present Value of Cash Flow (a-b) $55,037 5 $145,000 0.115 $16,675 6 $145,000 0.058 $8,410 Total $145,000

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