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$4.92

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

$ 8.22$8.22

million. Your discount rate for this contract is

7.7 %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?

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

The NPV of the project is

​$50.1550.15

million.  ​(Round to two decimal​ places.)

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

Present value = Annual cash flows x [ (1 – 1 / (1 + r)ⁿ) / r ]

So, the NPV is computed as follows:

= - $ 8.22 million + $ 4.92 million x [ (1 - 1 / (1 + 0.077)³³ ) / 0.077 ]

= - $ 8.22 million + $ 4.92 million x 11.86398374

= $ 50.15 million Approximately

b. If we take the contract, the value of the firm will increase by $ 50.15 million.

Feel free to ask in case of any query relating to this question