Question :

The Diamond Freight Company has been provided a seven-year contract to haul munitions for the government. Because this contract would show new business, the company could have to purchase several new heavy-duty trucks at a cost of $350,000 if the contract were accepted. Other data relating to the contract follow:

Annual net cash receipts (before taxes) from the contract

$105,000

Salvage value of the trucks at termination of the contract

$18,000

The trucks may have a useful life of seven years. To increase money to assist in the purchase of the new trucks, the company will sell some old, fully depreciated trucks for a net selling price of $16,000. The company needs a 16% after-tax return on all equipment purchases. The tax rate is 30%. For tax purposes, the company computes depreciation deductions considering zero salvage value and using straight-line depreciation on the full cost of the trucks ($350,000). The new trucks would be reduced over the seven year life.

Required:

(a) Evaluate the net present value of this investment opportunity.

Net present value           $

(b) Determine the internal rate of return of this investment opportunity.

Internal rate of return   %

(c) Would you recommend that the contract be accepted?