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

Question

Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $120,000. Of this amount, $70,000 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 $50,000. 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 $55,000 in working capital at the beginning of the first year and, of this amount, $25,000 will be returned to the Spartan Technology Company after six years.

  The investment will produce $50,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 10 percent cost of capital.

a.

Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

  Net present value $   

b. Should the investment be undertaken?

Yes
No

Explanation / Answer

The initial investment is: Land and equipment   120000 Working capital 55000 Initial investment                            $175,000 To determine annual depreciation under MACRS Percentage Depreciation Depreciation Annual Depreciation   $ Year Base 1 70000 0.2 14000 2 70000 0.32 22400 3 70000 0.192 13440 4 70000 0.115 8050 5 70000 0.115 8050 6 70000 0.058 4060 70000 To determine annual cash flow to be discounted Year 1 2 3 4 5 6 EBDT 50000 50000 50000 50000 50000 50000 Depreciation 14000 22400 13440 8050 8050 4060 Earnings bef Tax 36000 27600 36560 41950 41950 45940 Tax @ 40% 14400 11040 14624 16780 16780 18376 Earnings after tax 21600 16560 21936 25170 25170 27564 Add back depreciation 14000 22400 13440 8050 8050 4060 Add: Sale of non dep asset 50000 Add: Sale of non dep asset Add: Recovery of Working capital 25000 Total (Annual cash flow) 35600 38960 35376 33220 33220 106624 Discounted cash flow @ 10% cost of capital Year Annual cash flow PV factor @ 10% PV 0 -175000 1 -175000 1 35600 0.90909 32363.64 2 38960 0.82645 32198.35 3 35376 0.75131 26578.51 4 33220 0.68301 22689.71 5 33220 0.62092 20627.01 6 106624 0.56447 60186.47 Net Present Value 19643.68 a) NPV = $ 19,643.68 b) Yes, the project should be undertaken

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