Question

Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 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 $7.77 million. Your discount rate for this contract is 8.1%.

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?

Answer 1

Hello Sir/ Mam

Evaluating Cashflows:

Time	Cashflows	PVF	PV
0	-$7,770,000.00	1.00000	-$7,770,000.00
1	$4,920,000.00	0.92507	$4,551,341.35
2	$4,920,000.00	0.85575	$4,210,306.52
3	$4,920,000.00	0.79163	$3,894,825.65
Total			$4,886,473.52

Now,

(a) NPV rule states that :

• Reject the contract if NPV is negative.
• Accept the contract if NPV is positive.

Hence, NPV says ACCEPT THE PROJECT.

(b) The value of the firm will increase by $4,886,473.52

I hope this solves your doubt.

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