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 $370,000. Of this amount, $250,000 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 $120,000. 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 $58,000 in working capital at the beginning of the first year and, of this amount, $38,000 will be returned to the Spartan Technology Company after six years. The investment will produce $90,000 in income before depreciation and taxes for each of the six years. The corporation is in a 25 percent tax bracket and has a 5 percent cost of capital. a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

Table 12-12 Depreciation percentages (expressed in decimals), Depreciation Year 3-Year 5-Year MACRS MACRS 7-Year MACRS 10-Year 15-Year MACRS MACRS 20-Year MACRS 1 ........... 0.333 0.445 0.148 0.074 0.200 0.320 0.192 0.115 0.115 0.058 0.100 0.180 0.144 0.115 0.143 0.245 0.175 0.125 0.089 0.089 0.089 0.045 0.092 0.074 0.066 0.066 0.065 0.065 0.033 0.050 0.095 0.086 0.077 0.069 0.062 0.059 0.059 0.059 0.059 0.059 0.059 0.059 0.059 0.059 0.030 0.038 0.072 0.067 0.062 0.057 0.053 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.017 1.000 1.000 1.000 1.000 1.000 1.000

Answer 1

Net present value is used to evaluate investments.
Net present value	Present value of cash inflow - Present value of cash outflow
Calculation of net present value is shown below
Year	0	1	2	3	4	5	6
Income before depreciation and taxes		$90,000.00	$90,000.00	$90,000.00	$90,000.00	$90,000.00	$90,000.00
Depreciation		-$50,000.00	-$80,000.00	-$48,000.00	-$28,750.00	-$28,750.00	-$14,500.00
Income before taxes		$40,000.00	$10,000.00	$42,000.00	$61,250.00	$61,250.00	$75,500.00
Taxes @ 25%		-$10,000.00	-$2,500.00	-$10,500.00	-$15,312.50	-$15,312.50	-$18,875.00
Net income (a)		$30,000.00	$7,500.00	$31,500.00	$45,937.50	$45,937.50	$56,625.00
Depreciation (b)		$50,000.00	$80,000.00	$48,000.00	$28,750.00	$28,750.00	$14,500.00
Operating cash flow (a+b)		$80,000.00	$87,500.00	$79,500.00	$74,687.50	$74,687.50	$71,125.00
Initial investment	-$370,000.00
Net working capital	-$58,000.00
Recovery of net working capital							$38,000.00
After tax value of non-depreciable asset							$120,000.00
Net cash flow	-$428,000.00	$80,000.00	$87,500.00	$79,500.00	$74,687.50	$74,687.50	$229,125.00
Discount rate @ 5%	$1.000	$0.952	$0.907	$0.864	$0.823	$0.784	$0.746
Present value	-$428,000.00	$76,160.00	$79,362.50	$68,688.00	$61,467.81	$58,555.00	$170,927.25
Net present value	$87,160.56
Thus, net present value of project is $87,160.56.
Depreciation
1	50000	250000*0.20
2	80000	250000*0.32
3	48000	250000*0.192
4	28750	250000*0.115
5	28750	250000*0.115
6	14500	250000*0.058
Sale proceeds	120000
Cost of purchase	120000	(370000-250000)
Gain or loss on sale	0