The Thor Corporation has estimated the following cash flows for a project they p
ID: 2740353 • Letter: T
Question
The Thor Corporation has estimated the following cash flows for a project they plan to bid soon, requiring delivery of 20,000 special plastic hinges annually for five years. The company expects to incur an initial investment of $880,000 to purchase the necessary equipment. Net working capital of $50,000 will also be required in year 0 and none thereafter. The variable cost associated with producing each hinge is $20. The fixed cost per year is estimated $200,000. The equipment can be sold in five years for $100,000. The company uses a 15% cost of capital for similar projects and the marginal tax rate is 35%. Assume straight line depreciation.
Following up on Question 13, after some analysis, they forecast that their competition will bid at a price of $40. They would like to beat this price by quoting $38 per piece. What should the before tax salvage value be for the new equipment in year 5, in order for them to be able to quote $38 per piece.
Explanation / Answer
Calculate the In order for them to be able to quote $38 per piece:
Details
Amount
Number of units (20,000 *5)
100,000
Total cost:
Variable cost per unit
$ 20
Total variable cost
$ 2,000,000
Total fixed cost ($200,000*5)
$ 100,000
Total cost
$ 2,100,000
Add: Required return
($880,000 *15%)
$ 132,000
$ 2,232,000
Cost per unit = $2,232,000 / 100,000 units = $22.32 per unit
Quoted price is $38 is the greater than the cost price.
Note: Assume that tax not considered for the above calculations.
Details
Amount
Number of units (20,000 *5)
100,000
Total cost:
Variable cost per unit
$ 20
Total variable cost
$ 2,000,000
Total fixed cost ($200,000*5)
$ 100,000
Total cost
$ 2,100,000
Add: Required return
($880,000 *15%)
$ 132,000
$ 2,232,000
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