Question

Pacific Marine services has been offered a contract to provide highly classified services to the U.S....

Pacific Marine services has been offered a contract to provide highly classified services to the U.S. Navy. The contract is for 8 years. The projected costs and revenues for the project are given below:

Cost of new equipment$600,000

Working capital needed 90,000

Net annual Cash receipts 85,000

Equipment rebuilding cost Half way thru the contract 130,000

Salvage value of equipmentIn 8 years 30,000

A.Pacific Marine services cost of capital is 12 percent. Complete an analysis to determine whether or not this contract should be accepted by utilizing the Net Present Value Method. Should the contract be accepted? Explain, Show all your calculations in good form.

B.Complete the same analysis by using an alternative method of your choice. Should the contract be accepted based on this analysis.

C.Which method should Pacific Marine services utilize in future analyses of these types of decisions. Explain the pros and cons of each method.

Homework Answers

Answer #1
Initial Investment
Cost of new equipment        600,000.00
Working Capital          90,000.00
Total Invistment        690,000.00
Present Value of Inflows
Inflows Outflow Net Inflows Ptresent Value Factor Present Value
1              85,000                85,000         0.892857                 75,893
2              85,000                85,000         0.797194                 67,761
3              85,000                85,000         0.711780                 60,501
4              85,000               130,000              (45,000)         0.635518               (28,598)
5              85,000                85,000         0.567427                 48,231
6              85,000                85,000         0.506631                 43,064
7              85,000                85,000         0.452349                 38,450
8              85,000                85,000         0.403883                 34,330
8              30,000                30,000         0.403883                 12,116
8              90,000                90,000         0.403883                 36,349
              388,098
Present Value of Inflows        388,098.02
Less: Initial Investment        690,000.00
Net Present Value     (301,901.98)

Since we have negative NPV, the project will not be accepted.

Please note that it has been Assumed that the Equipment rebuilding cost will be incurred at the end of year 4.

For Your Understanding:

Working Capital is considered as outflow with Initial Investment and shown as inflow at the end of year 8. So effectively the time value of Working capital is captured in the question.


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