Question

Sheldon Coopers Lab Services (SCLS) is bidding upon a service contract to maintain and upgrade 2 of the University's science labs per year for the next six years.

The contract will require purchasing $1,331,000 in equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. The equipment can be sold for $325,000 at the end of the service contract. They will also need $140,000 in net working capital over the life of the contract.

While performing the contract work, they expect to incur fixed costs of $500,000 per year and a variable cost of $57,000 per lab. They will also face a corporate tax rate of 21%.

If the required rate of return is 15%, what is the minimum offer they can make per lab and still turn an economic profit?

*please show work. thank you*

Answer 1

Operating cash flow (OCF) each year = income after tax + depreciation

In year 6, the entire working capital investment is recovered.

profit on sale of equipment at end of year 6 = sale price - book value

book value is zero as the equipment is fully depreciated.

after-tax salvage value = salvage value - tax on profit on sale of equipment

NPV is calculated using NPV function in Excel

First, we assume the offer price to be $500,000 per lab, and we calculate the NPV.

NPV is -$292,634

The minimum offer price must be such that, the NPV is at least $0.

We calculate the minimum offer price using GoalSeek in Excel.

The minimum offer price is $555,251 per lab