You are required to submit a bid to supply 200,000,000 widgets per year to the S
ID: 2644812 • Letter: Y
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
We need to calculate the inflows and the outflows for the widget.
Outflow each year = 0.6 * 200000000 = 120,000,000
+ Fixed Cost = 800000
Additional Investment = 60000
Add:cost of deprciation = 4900000/5 = 980000
Total = 121840000
Net of Tax = 121840000 - Tax @ 34% =
Total = 80414400
PV of Annuity of the outflow = PVIFA (14%,5) for 80414400 = 276069146
Value of land sold after 5 years = 3500000 - Tax @ 34%
=2310000
Value of land inflow today = PVIF (14%,5) for 2310000
= 1199741
Initial Working Capital Requirement = 500000
Total Net outflow = Initial WC + PV of cost incurred every year for 5 years - Salvage value of land
= 500000 + 276069146 - 1199741
= $ 275369405
The above is the net cost to the firm for the entire contract the firm should add a mark up as applicable to this cost and quote the price for bid.
Note : The current cost of the land is sunk cost, since the company already owns the land .
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