Determine whether or not the contract should be accepted

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Reference no: EM132985889

Question: Reliable Corp. has been offered a seven-year contract to supply a part for the military.

The annual pre-tax cash flow from the contract is expected to be $90,000.

In order to take on the contract and manufacture the part, Reliable would need to purchase new manufacturing equipment for $300,000. In addition, it would need $50,000 in working capital to invest in new inventory.

It is not expected that the contract would be extended beyond the initial contract period. The company's after-tax cost of capital is 10%, and its tax rate is 30%.

At the end of the contract, the salvage value of the manufacturing equipment would be $10,000. The present value of the capital cost allowance (CCA) tax shield on the equipment is $81,818. There is no present value of the tax shield on the salvage value in the year of disposition as the equipment is eligible for a 100% CCA deduction in the year of purchase.

Assume initial outlays occur immediately and that annual cash flows occur at the end of the period.

Quantitatively, determine whether or not the contract should be accepted.

Reference no: EM132985889

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