Question

A company will submit a bid for the price per year it would charge to a new development for the next five years.
The company would have to buy new equipment for $110,000. The equipment would be depreciated straight-line to its estimated salvage value of $10,000 over its five-year useful life. At the end of the project, the company will be able to sell its equipment for $10,000. Also the company would use 3 trucks it currently has, which it could sell now for $50,000. These trucks are already fully depreciated, and will likely be sold in 5 years for a $10,000.
Working capital will increase by $30,000 to begin the project, and increase by an additional $10,000 in Year 1.
Total labor and other costs would be $80,000 a year. The tax rate is 25% percent and cost of capital is 10 percent.

What the minimum bid price per year need to be if the company wants to wind the bid and at least cover its cost of capital?

Answer 1

Tax rate		25%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost (110000-10000)		$       100,000	$      100,000	$       100,000	$       100,000	$      100,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	$         20,000	$        20,000	$         20,000	$         20,000	$        20,000	$       100,000
Calculation of after-tax salvage value		New Machine	Old Trucks- Sold today	Old Trucks-Sold 5 Yrs from today
Cost of machine			$      110,000	$                 -	$                 -
Depreciation			$      100,000	$                 -	$                 -
WDV	Cost less accumulated depreciation	$        10,000	$                 -	$                 -
Sale price			$        10,000	$         50,000	$         10,000
Profit/(Loss)	Sale price less WDV	$                -	$         50,000	$         10,000
Tax	Profit/(Loss)*tax rate	$                -	$         12,500	$           2,500
Sale price after-tax	Sale price less tax		$        10,000	$         37,500	$           7,500
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
Sale		$                 -	$                -	$                 -	$                 -	$                -
Less: Operating Cost		$         80,000	$        80,000	$         80,000	$         80,000	$        80,000
Contribution		$       (80,000)	$       (80,000)	$       (80,000)	$       (80,000)	$       (80,000)
Less: Depreciation		$         20,000	$        20,000	$         20,000	$         20,000	$        20,000
Profit before tax (PBT)		$     (100,000)	$     (100,000)	$     (100,000)	$     (100,000)	$     (100,000)
Tax@25%	PBT*Tax rate	$       (25,000)	$       (25,000)	$       (25,000)	$       (25,000)	$       (25,000)
Profit After Tax (PAT)	PBT - Tax	$       (75,000)	$       (75,000)	$       (75,000)	$       (75,000)	$       (75,000)
Add Depreciation	PAT + Dep	$         20,000	$        20,000	$         20,000	$         20,000	$        20,000
Cash Profit after-tax		$       (55,000)	$       (55,000)	$       (55,000)	$       (55,000)	$       (55,000)
Calculation of NPV
						10.00%
Year	Old trucks	Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0	$             (37,500)	$     (110,000)	$       (30,000)		$     (177,500)	1.0000	$     (177,500)
1			$       (10,000)	$       (55,000)	$       (65,000)	0.9091	$       (59,091)
2				$       (55,000)	$       (55,000)	0.8264	$       (45,455)
3				$       (55,000)	$       (55,000)	0.7513	$       (41,322)
4				$       (55,000)	$       (55,000)	0.6830	$       (37,566)
5	$                7,500	$         10,000	$        40,000	$       (55,000)	$           2,500	0.6209	$           1,552
					Net Present Value	$     (359,381)
PV of annual bid price after tax should be equal to NPV
Assumed bid price	P
Sum of PV factor	3.7908
PV of annual bid price after tax=	P*(1-25%)*3.7908
P*(1-25%)*3.7908=	$            359,381
P*2.8431=	$            359,381
Annual bid price annual=	$            126,405