Question

The managers of Poncho Parts, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next five years. The necessary foundry and machining equipment will cost a total of $800,000 and belongs in a 30% CCA class for tax purposes. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labour and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate. What is the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation? A) $1,692 B) $1,934 C) $2,382

Answer 1

Break even bid price/Minimum Bid Price Notes 1 Initial Cost at year o New Equipment Cost Working capital $ 800,000 $0 $ 800,000 N Depreciation Depreciation SLM basis over 5 years $ 800,000 5 $ 160,000 3 Terminal Value=Net proceeds from Sale of equipment As new euipment will be depreciated on straight-line basis to zero over the project's life., WDV at the end of year 5 will be $0.00 Net proceeds (Salvage Value - WDV at the end of year 5)*(1-t) Net proceeds ($150,000-0)*(1-0.35) Net proceeds $97,500.00 It has been assumed that tax @ 35% would be charged on Salvage value of equipment Bid Price Calculation NPV =-Initial outlay + Annual after tax cashflows* (P|A,1%,n) + Terminal value * (P/F,1%,n) = $0 NPV =-Initial outlay +Annual after tax cashflows* (P|A,11%,5) + Terminal value * (P/F,11%,5) = $0 $ 0.00 $ 0.00 OCF*3.6048 OCF -$800,000+ (OCF*3.6048) +($197,500*0.5674) -$800,000+ (OCF*3.6048) + $55324.12 $ 744,675.88 $ 206,580.34 OCF [(P-v)Q-FC](1-t) + tD [(P - $500) 250 - $125,000] (1-0.35)+(0.35)($160,000) $162.5P-$1,06,500

11 $ 206,580.34 P р $162.5P-$1,06,500 $ 1,926.65 $ 1,927 Bid Price P= Formula to find After tax Operating Cash flows (OCF) OCF [(P-v)Q-FC(1-t) +D OCF (Sales - Cost)*(1-T)+depreciation *T Where, Sales price per unit Variable cost per unit Q= No of units FC= Fixed cost tax rate Depreciation v= t= D= PV factor Formula (P/A,i,1) Uniform Series Present Worth Factor (1+i)" - 1 i(i+1) Takes a uniform series and moves it to a single payment one period earlier than the first payment of the series. 1 (P/F, 1, 1) Single payment present worth factor Moves a single payment to N periods earlier in time (1+i)"