Problem - The Diamond Freight Company has been offered a seven-year contract to haul munitions for the government. Because this contract would represent new business, the company would 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 will have a useful life of seven years. To raise money to assist in the purchase of the new trucks, the company will sell several old, fully depreciated trucks for a total selling price of $16,000. The company requires a 16% after-tax return on all equipment purchases.
The tax rate is 30%. For tax purposes, the company computes depreciation deductions assuming zero salvage value and using straight-line depreciation on the full cost of the trucks ($350,000). The new trucks would be depreciated over the seven year life.
Required:
(a) Compute the net present value of this investment opportunity.
(b) Compute the internal rate of return of this investment opportunity.
(c) Would you recommend that the contract be accepted?