Question

Please solve the following case using Excel and submit your assignment via Blackboard. You should work with your group on the case assignments (please write the names of all group members).

Jack Tar, CFO of Sheetbend & Halyard Inc. opened the company confidential envelope. It contained a draft of a competitive bid for a contract to supply duffel canvas to the U.S. Navy. The cover memo from Sheetbend's CEO asked Mr. Tar to review the bid before it was submitted.

The bid and its supporting documents had been prepared by Sheetbend's sales staff. It called for Sheetbend to supply 100,000 yards of duffel canvas per year for 5 years. The proposed selling price was fixed at $30 per yard.

Mr. Tar was not usually involved in sales, but this bid was unusual in at least two respects. First, if accepted by the navy, it would commit Sheetbend to a fixed-price, long-term contract. Second, producing the duffel canvas would require an investment of $1.5 million to purchase machinery and to refurbish Sheetbend's plant in Pleasantboro, Maine. Mr. Tar set to work and by the end of the week had collected the following facts and assumptions:

--> The plant in Pleasantboro had been built in the early 1900s and is now idle. The plant was fully depreciated on Sheetbend's books, except for the purchase cost of the land (in 1947) of $10,000.

Now that the land was valuable shorefront property, Mr. Tar thought the land could be sold, for $800,000 after 5 years. (Hint: do not forget to consider taxable gain on the sale. Tax due to sale equals: 0.35x(sale value –book value)).

• Refurbishing the plant would cost $500,000. This investment would be depreciated over 10 years as shown in the table below. The new machinery would cost $1 million. This investment would be depreciated over 5 years as shown in the table below.

• The refurbished plant and new machinery would last for many years. However, the remaining market for duffel canvas was small, and it was not clear that additional orders could be obtained once the navy contract was finished. The machinery was custom-built and could be used only for duffel canvas. Its secondhand value at the end of 5 years was probably zero. (Hint: When the project is shut down after five years, the machinery and plant will be worthless. The machinery will be fully depreciated, but the plant won’t be fully depreciated. The tax loss on plant will equal the book value since the market price of each asset is zero. Therefore, tax Reference: Chapter 9, Minicase, Fundamentals of Corporate Finance by Brealey, Myers, and Marcus. Eigth Edition. Irwin/McGraw-Hill. savings in year 5 equals: 0.35 x book value of the plant (i.e., original investment minus accumulated depreciation))

• Table 1 shows the sales staff's forecasts of income from the navy contract. Mr. Tar reviewed this forecast and decided that its assumptions were reasonable.

• But the forecast income statement contained no mention of working capital. Mr. Tar assumed a working capital investment of 10% of sales. Investment in working capital will be fully recovered at the end of the project in year 5.

However, when he finished debugging the spreadsheet, another confidential envelope arrived from Sheetbend’s CEO. It contained a firm offer from a Maine real estate developer to purchase Sheetbend’s Pleasantboro land and plant for $1.5 million in cash. Should Mr. Tar pursue the project if the discount rate for the project is 12%? Show all your work in excel sheet. Please enter the formulas (not the numbers) in the cells.

TABLE 1 Forecast income statement for the U.S. Navy duffel canvas project (dollar values in thousands, except price per yard) Year: 1 2 3 4 5 1. Yards sold 100.00 100.00 100.00 100.00 100.00 2. Price per yard 30.00 30.00 30.00 30.00 30.00 3. Revenue (1 x 2) 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 4. Cost of goods sold 2,100.00 2,184.00 2,271.36 2,362.21 2,456.70 5. Operating cash flow (3 – 4) 900.00 816.00 728.64 637.79 543.30 6. Depreciation 7. Income (5 – 6) 250,00 650.00 227.50 $422.50 250.00 566.00 198.10 $367.90 250.00 478.64 167.52 $311.12 250.00 387.79 135.72 $252.07 250.00 293.30 102.65 $190.65 8. Tax at 35% 9. Net income (7 – 8) Notes: 1. Yards sold and price per yard would be fixed by contract. 2. Cost of goods includes fixed cost of $300,000 per year plus variable costs of $18 per yard. Costs are expected to increase at the inflation rate of 4% per year. 3. Depreciation: A $1 million investment in machinery is depreciated straight-line over 5 years ($200,000 per year). The $500,000 cost of refurbishing the Pleasantboro plant is depreciated straight-line over 10 years ($50,000 per year).

Notes: 1. Yards sold and price per yard would be fixed by contract. 2. Cost of goods includes fixed cost of $300,000 per year plus variable costs of $18 per yard. Costs are expected to increase at the inflation rate of 4% per year. 3. Depreciation: A $1 million investment in machinery is depreciated straight-line over 5 years ($200,000 per year). The $500,000 cost of refurbishing the Pleasantboro plant is depreciated straight-line over 10 years ($50,000 per year).

Answer 1

Proposal A						($ value in thousands)
Particular	Year 1	Year 2	Year 3	Year 4	Year 5	PVF Cash flow
Net Income as per Table 1	422.50	367.90	311.12	252.07	190.65
Present value factor 12%	0.8929	0.7972	0.7118	0.6355	0.5674
	377.23	293.29	221.45	160.20	108.18	1,160.34
Sale of Land at 5th year				800*0.5674		453.92
Tax on Capital Gain(Sale of Land)				790*35%*.5674		(156.89)
Tax benefit on undepreciated value of plant @ 5th year				250*35%*.5674		49.65
Realisation of Working capital @ 5th year				10*.567427		5.67
				Total (A)		1,512.70
Initial Investment
Purchase of Machine						1,500.00
Working capital						10.00
				Total (B)		1,510.00
				Net present value (Gain)		2.70
Net present value of Proposal from Navy is Rs. 1512.70. Value of second proposal is 1,500 which is less than Navy proposal.
So, it s better to go ahead with U.S. Navy proposal						($ value in thousands) PVF Cash flow Proposal A Particular Year 1 Net Income as per Table 1 422.50 Present value factor 12% 0.8929 377.23 Sale of Land at 5th year Tax on Capital Gain(Sale of Land) Tax benefit on undepreciated value of plant @ 5th year Realisation of Working capital @ 5th year Year 2 367.90 0.7972 293.29 Year 3 311.12 0.7118 221.45 190.65 0.5674 108.18 Year 4 Year 5 252.07 0.6355 160.20 800*0.5674 790*35%*.5674 250*35%*.5674 108.567427 Total (A) 1,160.34 453.92 (156.89) 49.65 5.67 1,512.70 Initial Investment Purchase of Machine Working capital 1,500.00 10.00 1,510.00 Total (B) Net present value (Gain) 2.70 Net present value of Proposal from Navy is Rs. 1512.70. Value of second proposal is 1,500 which is less than Navy proposal. So, it s better to go ahead with U.S. Navy proposal