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 $5.19 million per year. Your upfront setup costs to be ready to produce the part would be $7.76 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?

Answer 1

a

Discount rate	7.700%
Year	0	1	2	3
Cash flow stream	-7.76	5.19	5.19	5.19
Discounting factor	1.000	1.077	1.160	1.249
Discounted cash flows project	-7.760	4.819	4.474	4.155
NPV = Sum of discounted cash flows
NPV Project =	5.69
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Accept project as NPV is positive

b

Firm value will increase by NPV = 5.69m