Problem 12-30 Working capital requirements in capital budgeting [LO12-4]

The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $300,000. Of this amount, $240,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $60,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

The contract will require an additional investment of $57,000 in working capital at the beginning of the first year and, of this amount, $37,000 will be returned to the Spartan Technology Company after six years.

The investment will produce $85,000 in income before depreciation and taxes for each of the six years. The corporation is in a 25 percent tax bracket and has a 8 percent cost of capital.

a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

b. Should the investment be undertaken?

multiple choice

• Yes Correct

• No