Question

Thor Industries is bidding on a contract for a 2-year investment project. The customer requires you to produce 500,000 widgets per year and the operating costs to produce that quantity of widgets is $3.25 million per year. The project will require an initial investment of $250 million for equipment that will be depreciated straight-line to zero over the two-year life. The equipment is expected to be scrapped for $10 million at the end of the project. The project will also require a $62.5 million initial investment in working capital. The firm’s marginal tax rate is 35% and their required rate of return on investments of similar risk is 12%. What minimum price should they bid per unit in order to earn their required return if they win the contract?

Answer 1

Answer:

Minimum price should they bid per unit in order to earn their required return is $392,020,089

Working Note:

Initial Cash flow (Year 0)
Initial investment	250,000,000.00
Add: Working Capital	62,500,000.00
Total Outflow	312,500,000.00

Particulars		Year 1	Year 2
Operating Cost		$       3,250,000.00	$      3,250,000.00
Depreciation * (1-35%)	250000000-10000000/2	$    78,000,000.00	$    78,000,000.00
Total Out flow		$    81,250,000.00	$    81,250,000.00

Terminal flow (Y2)
Salvage value after tax	(10,000,000.00)
Add recapture of working capital	(62,500,000.00)
Total terminal flow	(72,500,000.00)

Year	Cash Flow	PVF @ 12%	DCF
0	$ 312,500,000.00	$                     1.000	$     312,500,000.00
1	$    81,250,000.00	$                     0.893	$       72,544,642.86
2	$    81,250,000.00	$                     0.797	$       64,772,002.55
2	$ (72,500,000.00)	$                     0.797	$     (57,796,556.12)
Total Cash outflow			$           392,020,089