After spending $10,200 on client-development, you have just been offered a big production contract by a new client. The contract will add $196,000 to your revenues for each of the next five years and it will cost you $104,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for $54,000 now. If you use it in the project, it will be worthless at the end of the project. You will buy new equipment valued at $27,000 and use the 5-year MACRS schedule to depreciate it. It will be worthless at the end of the project. Your current production manager earns $85,000 per year. Since she is busy with ongoing projects, you are planning to hire an assistant at $38,000 per year to help with the expansion. You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project. Your company's tax rate is 21% and your discount rate is 15.8%. What is the NPV of the contract? (Note: Assume that the equipment is put into use in year 1.) Calculate the free cash flows below for years 0 through 2: (Round to the nearest dollar.) Year 0 Year 1 Year 2 Sales - Cost of Goods Sold Gross Profit -Annual Cost - Depreciation EBIT - Tax Incremental Earnings + Depreciation - Incremental Working Capital - Opportunity Cost - Capital Investment Incremental Free Cash Flow Sales -Cost of Goods Sold Gross Profit - Annual Cost - Depreciation EBIT - Tax $ Incremental Earnings + Depreciation - Incremental Working Capital - Opportunity Cost - Capital Investment Incremental Free Cash Flow S $ $ $ $ Calculate the free cash flows below for years 3 through 6: Year 3 $ $ $ $ $ $ $ $ $ $ $ $ $ Year 4 $ $ $ $ $ $ $ $ $ $ Year 5 $ $ $ $ $ C Year 6
After spending $10,200 on client-development, you have just been offered a big production contract by a new client. The contract will add $196,000 to your revenues for each of the next five years and it will cost you $104,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for $54,000 now. If you use it in the project, it will be worthless at the end of the project. You will buy new equipment valued at $27,000 and use the 5-year MACRS schedule to depreciate it. It will be worthless at the end of the project. Your current production manager earns $85,000 per year. Since she is busy with ongoing projects, you are planning to hire an assistant at $38,000 per year to help with the expansion. You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project. Your company's tax rate is 21% and your discount rate is 15.8%. What is the NPV of the contract? (Note: Assume that the equipment is put into use in year 1.) Calculate the free cash flows below for years 0 through 2: (Round to the nearest dollar.) Year 0 Year 1 Year 2 Sales - Cost of Goods Sold Gross Profit -Annual Cost - Depreciation EBIT - Tax Incremental Earnings + Depreciation - Incremental Working Capital - Opportunity Cost - Capital Investment Incremental Free Cash Flow Sales -Cost of Goods Sold Gross Profit - Annual Cost - Depreciation EBIT - Tax $ Incremental Earnings + Depreciation - Incremental Working Capital - Opportunity Cost - Capital Investment Incremental Free Cash Flow S $ $ $ $ Calculate the free cash flows below for years 3 through 6: Year 3 $ $ $ $ $ $ $ $ $ $ $ $ $ Year 4 $ $ $ $ $ $ $ $ $ $ Year 5 $ $ $ $ $ C Year 6
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section: Chapter Questions
Problem 14P
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Transcribed Image Text:After spending $10,200 on client-development, you have just been offered a big production contract by a new client. The contract will add $196,000 to your revenues for each of the next five years and it will
cost you $104,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for
$54,000 now. If you use it in the project, it will be worthless at the end of the project. You will buy new equipment valued at $27,000 and use the 5-year MACRS schedule to depreciate it. It will be worthless at
the end of the project. Your current production manager earns $85,000 per year. Since she is busy with ongoing projects, you are planning to hire an assistant at $38,000 per year to help with the expansion.
You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project. Your company's tax rate is 21% and your discount rate is 15.8%. What is the
NPV of the contract? (Note: Assume that the equipment is put into use in year 1.)
Calculate the free cash flows below for years 0 through 2: (Round to the nearest dollar.)
Year 0
Year 1
Year 2
Sales
- Cost of Goods Sold
Gross Profit
- Annual Cost
- Depreciation
EBIT
- Tax
Incremental Earnings
+ Depreciation
- Incremental Working Capital
- Opportunity Cost
- Capital Investment
Incremental Free Cash Flow
Sales
- Cost of Goods Sold
Gross Profit
-Annual Cost
- Depreciation
EBIT
- Tax
$
Incremental Earnings
+ Depreciation
- Incremental Working Capital
- Opportunity Cost
- Capital Investment
Incremental Free Cash Flow
$
$
$
$
$
Calculate the free cash flows below for years 3 through 6:
Year 3
$
$
$
$
$
$
$
$
$
$
$
$
$
Year 4
$
$
$
$
$
$
$
$
$
$
Year 5
$
$
$
$
$
Year 6
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