Question

Your company is preparing for a bid to supply garden tools to Garden Pro, Inc. The contract calls for 150,000 garden tools per year over the next four years. The installation of equipment necessary for the production will cost you $500,000. You will depreciate this cost straight-line to zero over the project’s life. You estimate that you can sell this equipment at the end of the project for $150,000 (pre-tax). The fixed production costs will be $100,000 per year, and the variable production costs should be $5 per unit. The project also requires $80,000 in initial investment in net working capital, which is fully recoverable at the end of the project. The tax rate is 25 percent. The project’s required rate of return is 15 percent. Find the price that makes the net present value (NPV) of the project equal to zero.

Answer 1

Solution: units Project life Equipment cost Depreciation=500000/4 Sale value FC VC initial investment in net working capital Tax rate Required return 150000 4 Years 500000 125000 150000 100000 80000 25% 15% **factor working : PVIFA(R%,n) PVIFA(15%,4) (1-(1+r)^-n)/ (1-(1.154-4))/0.15 | 2.8549784 Initial investment=(((SP-VC)*Q-FC-Dep)*(1-t)+Dep)*PVIFA(R%,n)+SV*(1-t) *PVIF(R%,n) + NWC*PVIF(R%,n) Let 'a' be the bid price. 500000+80000=(((a-5)*150000-100000-125000)*(1-0.25))+125000)*2.85497836+150000*0.57175325+80000*0.57175325 580000=(((150000a-750000-225000) *0.75)+125000)*2.85497836+64322.24+45740.26 580000=(112500a-731250+125000)*2.85497836+110062.5 580000=(112500a-606250)*2.85497836+110062.5 580000=321185.07a-1730830.63+110062.5 580000=321185.07a-1620768.13 321185.07a=580000+1620768.13 321185.07a=2200768.13 a=6.85 PVIF(R%,n) PVIF(15%,4) 1/(1+r)^n 1/(1.1544) 0.5717533 VC FC Dep Sale price variable cost Fixed cost Depreciation Sale value Net working capital NWC Sheet606 Sheet607 Sheet608 Sheet609 Sheet610 Sheet611 Sheet612 Sheet613 Sheet614_ 2 in TU ENG UK 12:32 26/03/2020