Again please answer step by step. A firm is considering bidding on a project to
ID: 2651834 • Letter: A
Question
Again please answer step by step.
A firm is considering bidding on a project to produce eight widgets per year for the next four years. In order to complete the project, the firm must lease facilities for $30,000 per year, purchase equipment that costs $100,000, as well as pay labour and material costs of $19,000 per unit produced. The equipment can be depreciated at the Class 8 CCA rate of 20%. At the end of the fourth year, it can be sold for $10,000, and the asset class will remain open after the disposal of the equipment. In addition, net working capital will increase by $50,000 if the project is undertaken, but these can be recovered at the end of the project. The company’s tax rate is 40%.
What is the minimum bid per widget if the firm requires 18% return on its investment?
Explanation / Answer
Answer:
Calculation of minimum bid price per widget
Year
PVF (18%)
Cash flows
PV
Cash flows * PVF
Purchase Cost of equipment
0
1
$ 100,000.00
$ 100,000.00
Cost of lease facilities (Net of tax) = 30000*(1-0.40)
1 to 4
2.69006
$ 18,000.00
$ 48,421.11
Labour and material costs (Net of tax) = 19000*4*(1-0.40)
1 to 4
2.69006
$ 45,600.00
$ 122,666.82
Net working capital invetsment
0
1.00000
$ 50,000.00
$ 50,000.00
Net working capital release
4
0.51579
$ (50,000.00)
$ (25,789.44)
Less: Tax Saving on depreciation
100000*20%*40%
1
0.847458
$ (8,000.00)
$ (6,779.66)
80000*20%*40%
2
0.718184
$ (6,400.00)
$ (4,596.38)
64000*20%*40%
3
0.608631
$ (5,120.00)
$ (3,116.19)
51200*20%*40%
4
0.515789
$ (4,096.00)
$ (2,112.67)
Disposal vallue of the equipment
4
0.515789
$ (10,000.00)
$ (5,157.89)
Tax on capital gain on sale of equipment
(10000 -40960)*40%
4
0.515789
$ (12,384.00)
$ (6,387.53)
Total Present value of cost for 4 widgets
$ 267,148.17
Cost per widget (Total /4)
$ 66,787.04
Hence the minimum bid per widget shall be $66787.04
Calculation of minimum bid price per widget
Year
PVF (18%)
Cash flows
PV
Cash flows * PVF
Purchase Cost of equipment
0
1
$ 100,000.00
$ 100,000.00
Cost of lease facilities (Net of tax) = 30000*(1-0.40)
1 to 4
2.69006
$ 18,000.00
$ 48,421.11
Labour and material costs (Net of tax) = 19000*4*(1-0.40)
1 to 4
2.69006
$ 45,600.00
$ 122,666.82
Net working capital invetsment
0
1.00000
$ 50,000.00
$ 50,000.00
Net working capital release
4
0.51579
$ (50,000.00)
$ (25,789.44)
Less: Tax Saving on depreciation
100000*20%*40%
1
0.847458
$ (8,000.00)
$ (6,779.66)
80000*20%*40%
2
0.718184
$ (6,400.00)
$ (4,596.38)
64000*20%*40%
3
0.608631
$ (5,120.00)
$ (3,116.19)
51200*20%*40%
4
0.515789
$ (4,096.00)
$ (2,112.67)
Disposal vallue of the equipment
4
0.515789
$ (10,000.00)
$ (5,157.89)
Tax on capital gain on sale of equipment
(10000 -40960)*40%
4
0.515789
$ (12,384.00)
$ (6,387.53)
Total Present value of cost for 4 widgets
$ 267,148.17
Cost per widget (Total /4)
$ 66,787.04
Hence the minimum bid per widget shall be $66787.04