Question: Morning Machine Works has obtained a contract from the government

Morning Machine Works has obtained a contract from the government to manufacture special parts for a new military aircraft. The parts are to be delivered over the next five years, and the company will be paid as the parts are delivered.
To make the parts, Morning Machine Works will have to purchase new equipment. Two types are available. Type A is conventional equipment that can be put into service immediately; it requires an immediate cash investment of $1,000,000 and will produce enough parts to provide net cash receipts of $340,000 in each of the five years specified in the contract. Type B requires one year to be put into service but is more efficient than Type A. The company can purchase Type B by signing a two-year non-interest-bearing note for $1,346,000. Type B is projected to produce net cash receipts of zero in year 1, $500,000 in year 2, $600,000 in year 3, $600,000 in year 4, and $200,000 in year 5. Morning Machine Works will not be able to use either type of equipment on other contracts, and neither type will have any useful life remaining at the end of the contract.
The company currently pays an interest rate of 16 percent to borrow money.
1. What is the present value of the investment required for each type of equipment?
2. Compute the net present value of each type of equipment based on your answer to 1 and the present value of the net cash receipts projected to be received.
3. Write a memorandum to the board of directors recommending the best option for Morning Machine Works. Explain your reasoning and include your answers to 1 and 2 as attachments.

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  • CreatedSeptember 10, 2014
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