Foie Company has been offered a six-year contract to supply a part to the military. After careful study, the

company has developed the following estimated data relating to the contract:

The equipment for each project is in Class 22 with a 30% CCA rate. The company would take the maximum CCA allowable

each year. It is not expected that the contract would be extended beyond the initial contract period of six years. The working

capital would be released for use elsewhere at the end of the contract. The income tax rate is 30%. Foie's after-tax cost of

capital is 12%. Assume that the salvage value of the Equipment which is received at the end of the contract is NOT subject

to tax.

Required: PLEASE SHOW ALL OF YOUR CALCULATIONS

a) [8 MARKS] Use net present value analysis to determine whether or not the contract should be accepted. Based on your

Net Present Value analysis should the contract be accepted? (Round all calculations to the nearest dollar.) THE PRESENT

VALUE OF EACH INFLOW AND/OUTFLOW OF CASH MUST BE CALCULATED SEPARATELY. FOR

EXAMPLE, THE PRESENT VALUE OF THE ANNUAL NET CASH INFLOW MUST BE CALCULATED

SEPARATELY FROM THE PRESENT VALUE OF THE CASH INFLOW FROM THE SALVAGE VALUE OF

EQUIPMENT.

b) [2 MARKS] If instead of using a net present value analysis, the company decided to use the payback method in order to

decide whether or not to accept this contract, can you think of two drawbacks (i.e. criticisms) with the use of this method?

Please state them in no more than two sentences.

c) [2 MARKS] Suppose that Foie Company is offered not only the six-year supply contract stated above, but also a different

six-year supply contract that requires an initial investment of $250,000 instead of the $130,000 required in the above stated

contract. Since Foie Company does not have the financial resources to accept both projects, it must decide between the two.

Is there any problem with using the net present value method to rank these two projects? If so, what is, it and how can it be

rectified (i.e. corrected)? Your answer should not exceed two sentences

Cost of equipment needed $90,000 Working capital needed to carry inventories $40,000 Annual net cash inflow $25,000 Salvage value of equipment $8,000