Net Present Value Analysis Champion Company is considering a

Net Present Value Analysis Champion Company is considering a contract that would require an expansion of its food processing capabilities. The contract covers five years. To provide the required products, Champion would have to purchase additional equipment for $80,000. Champion estimates the contract will provide annual net cash inflows (before taxes) of $35,000. For tax purposes, the equipment will be depreciated as follows: Year 1 $S10,000 Year 2 20,000 Year 3 20,000 Year 4 20,000 Year 5 10,000 Although salvage value is ignored in the tax depreciation calculations, Champion estimates the equipment will be sold for $10,000 after five years. Assuming a 35% income tax rate and a 10% cutoff rate, compute the net present value of this contract proposal. Using net present value analysis, should Champion accept the contract? Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers. After-Tax Cash Flow Analysis Amount Present Value After-tax cash inflows for 5 years Tax savings from depreciation Year 1 Year 2 Year 3 Year 4 Year 5 After-ta x equipment sale proceeds Total present value of future cash flows Investment required in equipment Net positive (negative) present value Should Champion accept the contract? Select the most appropriate answer below. OChampion should accept the contract because there is a negative net present value Champion should not accept the contract because there is a positive net present value. OChampion should accept the contract because there is a positive net present value OChampion should not accept the contract because there is a negative net present value

Solution

Year Cash Inflow Tax savings from Depreciation Total Cash Inflow PV @ 10% PV of cash inflows 1 $ 113,750.00 $          10,000.00 $ 123,750.00 0.90909 $ 112,500.00 2 $ 113,750.00 $          20,000.00 $ 133,750.00 0.82644 $ 110,536.35 3 $ 113,750.00 $          20,000.00 $ 133,750.00 0.75130 $ 100,486.38 4 $ 113,750.00 $          20,000.00 $ 133,750.00 0.68301 $    91,352.59 5 $ 113,750.00 $          10,000.00 $ 123,750.00 0.62092 $    76,838.85 TOTAL $ 491,714.16 Salvage Value 5 $      6,500.00 $      6,500.00 0.62092 $      4,035.98 Cash Outflow 0 $ (80,000.00) 1.00000 $ (80,000.00) NPV $ 415,750.14 Thus option C to be choosen as NPV is positive