Question

ViNdia Breakeven

You are the CFO of ViNdia, a maker of semi-conductors for gaming consoles and the automotive market. You have the opportunity

•  You are considering bidding on a project to supply 5 million specialized GPU’s per year to Fjord Motor for the next five years.

•  In order to fill this order, you will have to build a new plant. You have an idle parcel of land available that you purchased for $1,000,000 five years ago. If the land were sold today, you would receive $1,150,000.

•  You will need to invest $2,100,000 in a new manufacturing plant and equipment that will be depreciated on a straight-line basis over its useful life of 7 years. You estimate that the equipment, plant, and land will be worth $3,000,000 at the end of five years.

•  You will need to invest $600,000 in initial working capital and an additional $50,000 each year to support the project.

•  You estimate the variable cost will be $2.50 per unit, and fixed costs will be $800,000 per year.

  Assuming you have a 12.5% cost of capital and a 21% tax rate, what is the minimum bid price per stamp you should submit?

Answer 1

First, we assume the bid price to be $5.00, and compute the NPV.

The historical cost of the land, and its current market value are irrelevant because the land is idle. They should not be considered in the cash flow analysis.

Operating cash flow (OCF) each year = income after tax + depreciation - investment in working capital

In year 7, the entire working capital investment is recovered, and hence the investment in working capital is negative

profit on sale of plant at end of year 7 = sale price - book value

book value = original cost - accumulated depreciation

The book value is zero as the plant is fully depreciated

after-tax salvage value = salvage value - tax on profit on sale of plant   

NPV is calculated using NPV function in Excel

NPV is $40,336,432

B C D I I G H I $ 5.00 1 Bid Price 2 3 Initial Investment 4 Cost of plant $2,100,000 6 OCE 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Income before tax 13 - Taxes 14 Income after tax 15 Depreciation 16 Investment in working capital 17 OCF 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 ($900,000) $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $10,206,000 $600,000 ($600,000) $3,000,000 $630,000 $2,370,000 19 Terminal Cash Flow 20 Salvage Value 21 Tax 22 Salvage Value after tax 23 24 NPV Analysis 25 Project Cash Flows 26 27 NPV ($2,700,000) $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $12,576,000 $40,336,432

В 1 Bid Price 5 0 14 3 Initial Investment 4 Cost of plant 2100000 5 6 OCF 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Income before tax 13 - Taxes 14 Income after tax 15 + Depreciation 16 Investment in working capital 600000 17 OCF =B14+B15-B16 5000000 5000000 5000000 5000000 5000000 5000000 5000000 =C7*$B$1 =D7*$B$1 =E7*$B$1 =F7*$B$1 =G7*$B$1 =H7*$B$1 =17*$B$1 =C7*2.5 =D7*2.5 =E7*2.5 =F7*2.5 =G7*2.5 =H72.5 =17*2.5 800000 800000 800000 800000 800000 800000 800000 =$B$4/7 =$B$4/7 =$B$4/7 =$B$4/7 =$B$4/7 =$B$4/7 =$B$4/7 =C8-C9-C10-C11 =D8-D9-D10-D11 =E8-E9-E10-E11 =F8-F9-F10-F11 =G8-G9-G10-G11 =H8-H9-H10-H11 =18-19-110-111 =C12 21% =D12-21% =E12*21% =F12*21% =G12*21% =H12-21% =11221% =C12-C13 =D12-D13 =E12-E13 =F12-F13 =G12-G13 =H12-H13 =112-113 =C11 =D11 =E11 =F11 =G11 =H11 =111 50000 50000 50000 50000 50000 50000 --SUM(B16:H16) =C14+C15-C16 =D14+D15-D16 =E14+E15-E16 =F14+F15-F16 =G14+G15-G16 =H14+H15-H16 =114+115-116 18 19 Terminal Cash Flow 20 Salvage Value 21 Tax 22 Salvage Value after tax 3000000 =120*21% =120-121 24 NPV Analysis 25 Project Cash Flows --B4+B17 =C17 =D17 =E17 =F17 =G17 =H17 =117+122 26 27 NPV =NPV(12.5%,C25:125)+B25

The minimum bid price is the bid price where NPV is positive.

We use GoalSeek in Excel to find the minimum bid price, such that NPV is at least $1

B C D E F G H $ 5.00 12 $2,100,000 Goal Seek 1 Bid Price 2 3 Initial Investment 4 Cost of plant 5 6 OCF 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Income before tax 13 - Taxes 14 Income after tax 15 + Depreciation 16 Investment in working capital 17 OCF 18 19 Terminal Cash Flow 20 Salvage Value 21 Tax 22 Salvage Value after tax 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $12,500,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $800,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $11,400,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $2,394,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $9,006,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $300,000 $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 ($900,000) $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $10,206,000 Set cell: SBS 27 To value: By shanging cell: $B$1 OK | Cancel $600,000 ($600,000) $3,000,000 $630,000 $2,370,000 24 NPV Analysis 25 Project Cash Flows ($2,700,000) $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $9,256,000 $12,576,000 26 27 NPV 28 $40,336,432

The minimum bid price is $2.73

B c o E F G H I 1 Bid Price $ 2.73 3 Initial Investment 4 Cost of plant $2,100,000 6 OCF 7 Units sold 8 Revenues 9 - Variable Costs 10 - Fixed Costs 11 - Depreciation 12 Income before tax 13 - Taxes 14 Income after tax 15 Depreciation 16 Investment in working capital 17 OCF 5,000,000 $13,634,160 $12,500,000 $800,000 $300,000 $34,160 $7,174 $26,986 $300,000 $50,000 $276,986 5,000,000 $13,634,160 $12,500,000 $800,000 $300,000 $34,160 $7,174 $26,986 $300,000 $50,000 $276,986 5,000,000 5,000,000 5,000,000 $13,634,160 $13,634,160 $13,634,160 $12,500,000 $12,500,000 $12,500,000 $800,000 $800,000 $800,000 $300,000 $300,000 $300,000 $34,160 $34,160 $34,160 $7,174 $7,174 $7,174 $26,986 $26,986 $26,986 $300,000 $300,000 $300,000 $50,000 $50,000 $50,000 $276,986 $276,986 $276,986 5,000,000 $13,634,160 $12,500,000 $800,000 $300,000 $34,160 $7,174 $26,986 $300,000 $50,000 $276,986 5,000,000 $13,634,160 $12,500,000 $800,000 $300,000 $34,160 $7,174 $26,986 $300,000 ($900,000) $1,226,986 $600,000 ($600,000) 18 19 Terminal Cash Flow 20 Salvage Value 21 Tax 22 Salvage Value after tax $3,000,000 $630,000 $2,370,000 24 NPV Analysis 25 Project Cash Flows ($2,700,000) $276,986 $276,986 $276,986 $276,986 $276,986 $276,986 $3,596,986 26 27 NPV $1