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.
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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