Question

F- You are working on a bid to build two city parks a year for the next three years. This project requires the purchase of $249,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the three-year project life. Ignore bonus depreciation. The equipment can be sold at the end of the project for $115,000. You will also need $18,000 in net working capital for the duration of the project. The fixed costs will be $37,000 a year and the variable costs will be $148,000 per park. Your required rate of return is 14 percent and your tax rate is 21 percent. What is the minimal amount you should bid per park? (Round your answer to the nearest $100)

Answer 1

A	Initial Cash Outflow:
	Purchase of Equipment	$           249,000
	Net Working Capital	$             18,000
	PV of Cash Outflows	$           267,000
B	Terminal Cash Inflows:
a	Sale of Equipment at end of Project	$           115,000
	Less: Book Value	$                       -
	Capital Gain	$           115,000
	Less: Tax @ 21%	$             24,150
b	Net Cash Inflow on Sale of Equipment	$             90,850
	Net Working Capital	$             18,000
c	Termianl Cash Inflow (a+b)	$           108,850
	PVF(14%,3 yr)	0.6750
	PV of Terminal Cash Inflow	$             73,471
C	Operational Cash flows
	Annual Fixed Costs	$             37,000
	Annual Variable Costs	$           148,000
	Annual Operational Costs	$           185,000
	Depreciation per year ($ 249,000/3years)	$             83,000
	Expenses for the year	$           268,000
	Less: Tax Savings @ 21% per year	$             56,280
	Expenses net of taxes	$           211,720
	Add: Depreciation	$             83,000
	Net Operating Cash Outflows	$           128,720
D	Computation of Minimal Bid
	a. Annualised Net Cash flow on A/c of Capital Expenses
	Initial Cash Outflow	$           267,000
	Less: Terminal Cash Inflow	$           (73,471)
	Net Cash flow on Account of Capex	$           340,471
	PVAF(14%,3yrs)	2.3216
	Annualised Capital Expense($340,471/2.3216)	$           146,651
	b. Annual Operating Expenses	$           128,720
	c. Minimal Amount of Bid (a+b) = $ 275,371	$           275,400
	(Rounded to nearest $100)
	Computation of PVAF(14%, 3 years)
	PVAF = ((1-(1+i)^-n)/i
	(1+i)^-n = (1.14)^-3 = 0.6750
	PVAF = 0.3250/0.14 = 2.3216