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Guthrie Enterprises needs someone to supply it with 145,000 cartons of machine screws per year to...
Guthrie Enterprises needs someone to supply it with 145,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $3 million to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. The market value of the retired machine is zero. Your production costs will be $1,955,000 per year. You also need an initial investment in net working capital of $325,000, which will be fully recovered in the end of the project. If your tax rate is 20 percent and you require a 10 percent return on your investment, what bid price should you submit?
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Expert Solution
| Tax rate | 20% | ||||||
| Calculation of annual depreciation | |||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Total | |
| Cost | $ 3,000,000 | $ 3,000,000 | $ 3,000,000 | $ 3,000,000 | $ 3,000,000 | ||
| Dep Rate | 20.00% | 20.00% | 20.00% | 20.00% | 20.00% | ||
| Depreciation | Cost * Dep rate | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | $ 3,000,000 |
| Calculation of after-tax salvage value | |||||||
| Cost of machine | $ 3,000,000 | ||||||
| Depreciation | $ 3,000,000 | ||||||
| WDV | Cost less accumulated depreciation | $ - | |||||
| Sale price | $ - | ||||||
| Profit/(Loss) | Sale price less WDV | $ - | |||||
| Tax | Profit/(Loss)*tax rate | $ - | |||||
| Sale price after-tax | Sale price less tax | $ - | |||||
| Calculation of annual operating cash flow | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |||
| No of units | 145,000 | 145,000 | 145,000 | 145,000 | 145,000 | ||
| Sale | $ - | $ - | $ - | $ - | $ - | ||
| Less: Operating Cost | $ 1,955,000 | $ 1,955,000 | $ 1,955,000 | $ 1,955,000 | $ 1,955,000 | ||
| Contribution | $ (1,955,000) | $ (1,955,000) | $ (1,955,000) | $ (1,955,000) | $ (1,955,000) | ||
| Less: Depreciation | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | ||
| Profit before tax (PBT) | $ (2,555,000) | $ (2,555,000) | $ (2,555,000) | $ (2,555,000) | $ (2,555,000) | ||
| Tax@20% | PBT*Tax rate | $ (511,000) | $ (511,000) | $ (511,000) | $ (511,000) | $ (511,000) | |
| Profit After Tax (PAT) | PBT - Tax | $ (2,044,000) | $ (2,044,000) | $ (2,044,000) | $ (2,044,000) | $ (2,044,000) | |
| Add Depreciation | PAT + Dep | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | $ 600,000 | |
| Cash Profit after-tax | $ (1,444,000) | $ (1,444,000) | $ (1,444,000) | $ (1,444,000) | $ (1,444,000) | ||
| Calculation of NPV | |||||||
| 10.00% | |||||||
| Year | Capital | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values | |
| 0 | $ (3,000,000) | $ (325,000) | $ (3,325,000) | 1.0000 | $ (3,325,000) | ||
| 1 | $ (1,444,000) | $ (1,444,000) | 0.9091 | $ (1,312,727) | |||
| 2 | $ (1,444,000) | $ (1,444,000) | 0.8264 | $ (1,193,388) | |||
| 3 | $ (1,444,000) | $ (1,444,000) | 0.7513 | $ (1,084,899) | |||
| 4 | $ (1,444,000) | $ (1,444,000) | 0.6830 | $ (986,271) | |||
| 5 | $ - | $ 325,000 | $ (1,444,000) | $ (1,119,000) | 0.6209 | $ (694,811) | |
| Net Present Value | $ (8,597,097) | ||||||
| Assumed annual revenue | R | ||||||
| Sum of PV factor for year 1-5 | 3.7908 | ||||||
| PV of revenue from year 1-5 | R*3.7908*(1-20%) | 3 | |||||
| PV of revenue from year 1-5 | R*3.03262941552676 | ||||||
| R*3.03262941552676= | $ 8,597,097 | ||||||
| R= | 8597096.66503157/3.03262941552676 | ||||||
| R= | $ 2,834,866 | ||||||
| Bid per carton= | 2834865.55298029/145000 | ||||||
| Bid per carton= | $ 19.55 |
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