QUESTION 3

Uncertain Future Cash Flows

Viola Manufacturing Company consists of several divisions, one of which is the Transportation Division. The company has decided to dispose of this division because it no longer fits the company's long-term strategy. An offer of $9,000,000 has been received from a prospective buyer. If Viola retained the division, the company would operate the division for only nine years, after which the division would no longer be needed and would be sold for $600,000. If the company retains the division, an immediate investment of $500,000 would need to be made to update equipment to current standards. Annual net operating cash flows would be $1,805,000 if the division is retained. The company's discount rate is 12%. (Ignore income taxes in this problem.)

Required:

Using the net present value method, determine whether Viola Manufacturing should accept or reject the offer made by the potential buyer.