You are required to submit a bid to supply 200,000,000 widgets per year to the S

Question

You are required to submit a bid to supply 200,000,000 widgets per year to the State of Illinois for the next five years. Your company has an idle tract of real estate that cost $1,500,000 ten years ago; if your company sold the land today, it would generate $3,000,000 after the taxes were paid. The land can be sold for $3,500,000 after taxes in five years. You will need to install $4,900,000 in new plant and equipment to actually produce the widgets; this plant and equipment will be depreciated straight-line to zero over the projects five year life. The equipment can be sold for $610,000 at the end of the project. You will need $500,000 in initial working capital for the project, and an additional investment of $60,000 in every year thereafter. Your production costs are .6 cents per widget and you will have fixed costs of $800,000 per year. If your tax rate is 34% and your required return is 14%, what bid price per widget should you submit?

Explanation / Answer

Note : Every amount is discounted to time T = 5 years ( 5years from present time)

Future value = Present Value * ( 1 + rate/100) ^ T

Let the rate of inflation be r % p.a.

Step 1 : Calculate the Fixed cost

Plant = $4,900,000 * ( 1+ r/100)^5 .....a

Initial working capital = $500,000 * ( 1+ r/100)^5 .......b

Discounted additional investment = 60000 [ (1+r/100)^1 + (1+r/100)^2 +

(1+r/100)^3 + (1+r/100)^4 + (1+r/100)^5 ] .......c

Discounted Fixed cost = 800000 [ (1+r/100)^1 + (1+r/100)^2 +

(1+r/100)^3 + (1+r/100)^4 + (1+r/100)^5 ]   .......d

Step 2 : Calculate variable cost

Let the bid price per widget be 'x'

Variable cost per year = 0.6 cents * 200,000,000 = $1,200,000

Total Vartiable cost = 1,200,000 * [(1+r/100)^1 + (1+r/100)^2 +

(1+r/100)^3 + (1+r/100)^4 + (1+r/100)^5 ]    .......e

(1+r/100)^3 + (1+r/100)^4 + (1+r/100)^5 ]    .......h

Step 5 : Calculate net profit

Net profit = f + g + h - ( a + b + c + d + e)

Step 6 : Calculate Profit after tax

Profit after tax  = ( 1 - 34/100 ) * Net Profit

Step 7: Calculation of bid price per widget.

Profit after tax = 14 % of (a +b + c +d +e)

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