Net Present Value Analysis
Champion Company is considering a contract that would require an
expansion of its food processing capabilities. The contract covers
five years. To provide the required products, Champion would have
to purchase additional equipment for $88,000. Champion estimates
the contract will provide annual net cash inflows (before taxes) of
$38,000. For tax purposes, the equipment will be depreciated as
follows:
| Year 1 | $11,000 |
| Year 2 | 22,000 |
| Year 3 | 22,000 |
| Year 4 | 22,000 |
| Year 5 | 11,000 |
Although salvage value is ignored in the tax depreciation
calculations, Champion estimates the equipment will be sold for
$11,000 after five years.
Assuming a 35% income tax rate and a 10% hurdle rate, compute the net present value of this contract proposal. Using net present value analysis, should Champion accept the contract?
Round answers to the nearest whole number. Use rounded answers for
subsequent calculations.
Use a negative sign with net present value to indicate a negative
amount. Otherwise do not use negative signs with your answers.
| After-Tax Cash Flow Analysis | ||
|---|---|---|
| Amount | Present Value | |
| After-tax cash inflows for 5 years | Answer | Answer |
| Tax savings from depreciation | ||
| Year 1 | Answer | Answer |
| Year 2 | Answer | Answer |
| Year 3 | Answer | Answer |
| Year 4 | Answer | Answer |
| Year 5 | Answer | Answer |
| After-tax equipment sale proceeds | Answer | Answer |
| Total present value of future cash flows | Answer | |
| Investment required in equipment | Answer | |
| Net positive (negative) present value | Answer | |
Should Champion accept the contract?
Select the most appropriate answer below.
Champion should accept the contract because there is a negative net present value.
Champion should not accept the contract because there is a positive net present value.
Champion should accept the contract because there is a positive net present value.
Champion should not accept the contract because there is a negative net present value.
| Statement showing computation of NPV- Champion Company | |||
| Amount | PVF @ 10% | Present Value | |
| (a) | (b) | (aXb) | |
| After Tax Cash Inflows for 5 year ( 38000X0.65) | $24,700.00 | 3.791 | $93,637.70 |
| Tax Savings From Depreciation | |||
| Year 1 | $11,000.00 | 0.909 | $9,999.00 |
| Year 2 | $22,000.00 | 0.826 | $18,172.00 |
| Year 3 | $22,000.00 | 0.751 | $16,522.00 |
| Year 4 | $22,000.00 | 0.683 | $15,026.00 |
| Year 5 | $11,000.00 | 0.621 | $6,831.00 |
| Salvage Value of Equipment | $11,000.00 | 0.621 | $6,831.00 |
| Present Value Of Cash InFlow | $167,018.70 | ||
| Less: Investment in Equipment | $88,000.00 | ||
| Net Present Value | $79,018.70 |
Champion should accept the contract because there is a positive net present value.
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