Question

The sales department of Yemek Catering worked with the production department to prepare the bid and supporting documents. The bid requires Yemek Catering to provide 2520 lunch meals per year for the next 5 years. The proposed selling price in the first year is 15 TL per meal and is expected to increase in line with inflation. Yemek Catering has negotiated a 12 percent increase in selling price with the manufacturing company to compensate for inflation. The expenses of providing the dining services total 25200 TL and are also expected to increase with inflation of 12%.

Yemek Catering needs to invest in additional equipment worth 20,000 TL to provide catering services to the manufacturing firm in the next five years. The investment in equipment would be depreciated for tax purposes straight line over 5 years to zero. However, Yemek Catering believes that it can keep using this equipment in other contracts that it would land after five years. If Yemek Catering cannot secure new contracts in 5 years, it can sell the second-hand equipment for 5,000 TL (assume selling of equipment takes place at the end of year 5).

Yemek Catering also forecasts that to provide the lunch service it would need to invest in working capital. Working capital would average 10 percent of current year’s sales.

What is your recommendation regarding the bid to your CFO? Should Yemek Catering bid for the contract if the discount rate for the project is 22 percent and the tax rate is 20 percent?