Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for

33

years and your cash flows from the contract would be

$ 4.92

million per year. Your upfront setup costs to be ready to produce the part would be

$ 8.22

million. Your discount rate for this contract is

7.7 %

a. What does the NPV rule say you should​ do?

b. If you take the​ contract, what will be the change in the value of your​ firm?

 ​(Round to two decimal​ places.)

Answer 1

To find the NPV, we first discount all the future cash-flows from the contract

Using a financial calculator

FV = 0

PMT = 4.92

I/Y = 7.7

N = 33

cpt PV,we get PV = $58.37 million

NPV = PV of future cash-flows - Initial investment

NPV = $58.37 million - $8.22 million = $50.15 million

a.

Since the NPV is positive, the project should be taken up

b.

If the contract is taken up, the change in value of the firm would be equal to the NPV of the project ie. $50.15 million