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 $185,000. Of this amount, $160,000 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 $25,000. 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 $49,000 in working capital at the beginning of the first year and, of this amount, $29,000 will be returned to the Spartan Technology Company after six years.

The investment will produce $61,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 6 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?

Explanation / Answer

Cashflow calcualtion Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 a PBITDA $          61,000 $ 61,000 $ 61,000 $ 61,000 $ 61,000 $ 61,000 b Depreciation $          32,000 $ 51,200 $ 30,720 $ 18,432 $ 18,432 $    9,216 c Profit after depreciation $          29,000 $    9,800 $ 30,280 $ 42,568 $ 42,568 $ 51,784 d TAX @ 40% $          11,600 $    3,920 $ 12,112 $ 17,027 $ 17,027 $ 20,714 e Profit after tax (c-d) $          17,400 $    5,880 $ 18,168 $ 25,541 $ 25,541 $ 31,070 f Cashflow (e+b) $          46,400 $ 15,680 $ 48,448 $ 68,109 $ 68,109 $ 82,854 Depreciation Schedule Opening Balance Depreciation rate Depreciation Closing Balance 1                    160,000 20.00%              32,000                 128,000 2                    128,000 32.00%              51,200                    76,800 3                      76,800 19.20%              30,720                    46,080 4                      46,080 11.52%              18,432                    27,648 5                      27,648 11.52%              18,432                      9,216 6                         9,216 5.76%                9,216                             -   NPV Calcualtion Year Particulars Cashflow Discounting factor @6% Discounted cashflow 0 Inintial Cost $       (185,000) 1.0000      (185,000) 0 Working capital $ (49,000) 1.0000         (49,000) 1 Cashflow $ 46,400 0.9434           43,774 2 Cashflow $ 15,680 0.8900           13,955 3 Cashflow $ 48,448 0.8396           40,678 4 Cashflow $ 68,109 0.7921           53,949 5 Cashflow $ 68,109 0.7473           50,895 6 Cashflow $ 82,854 0.7050           58,409 6 Salvage cost $ 25,000 0.7050           17,624 6 Working capital $ 29,000 0.7050           20,444 Total           65,727

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