The Thor Corporation has estimated the following cash flows for a project they p

Question

The Thor Corporation has estimated the following cash flows for a project they plan to bid soon, requiring delivery of 20,000 special plastic hinges annually for five years. The company expects to incur an initial investment of $880,000 to purchase the necessary equipment. Net working capital of $50,000 will also be required in year 0 and none thereafter. The variable cost associated with producing each hinge is $20. The fixed cost per year is estimated $200,000. The equipment can be sold in five years for $100,000. The company uses a 15% cost of capital for similar projects and the marginal tax rate is 35%. Assume straight line depreciation.

Following up on Question 13, after some analysis, they forecast that their competition will bid at a price of $40. They would like to beat this price by quoting $38 per piece. What should the before tax salvage value be for the new equipment in year 5, in order for them to be able to quote $38 per piece.

Please provide detailed answer

Explanation / Answer

Using 40/unit price and a salvage value of 100,000 we get a Total Cash Flow at end of year 5 = -438468

After Tax Salvage = Future Value Excess of Initial Cash Outflow Flow - Future Value of Cash Inflow from Operations (other than Salvage Value) = 1870562 (future value of initially investment) - 998192 (future value of cash in flow) + 438468 (difference due to unit price) = 433901.9

Before Tax Salvage Value = After Tax Salvage Value / Tax Rate + Book Value of Equipment = 433901.9/0.35 + 100000 = 767541.4

Year 0 1 2 3 4 5 i Quantity 20000 20000 20000 20000 20000 ii Price/Unit 38 38 38 38 38 iii Total Revenue (= i x ii) 760000 760000 760000 760000 760000 iv Initial Investment / Purchase Price -880000 v WC Expense -50000 vi Change in WC 50000 0 0 0 0 vii Variable Cost/Unit 20 20 20 20 20 viii Total Vairable Cost (= i x vi) -400000 -400000 -400000 -400000 -400000 ix Fixed Cost -200000 -200000 -200000 -200000 -200000 x Equipment Value at end 5th yr 100000 xi Depreication (= (Purchase Price - Value at 5th yr)/5) -156000 -156000 -156000 -156000 -156000 xii Profit Before Tax 4000 4000 4000 4000 4000 xiii Tax Rate 35% xiv Tax (= xii * xi) -1400 -1400 -1400 -1400 -1400 xvi Profit After Tax (= xi + xiii) 2600 2600 2600 2600 2600 xvii Before Tax Salvage Value 100000 xviii Tax on Salvage 35% 0 xix After Tax Salvage Value 100000 xx Cash Flow -930000 208600 158600 158600 158600 158600 xxi Discount Rate 15% xxii Future Value -1870562.184 364842.7 241210.8 209748.5 182390 158600 xiii Future Value of Cash Inflow 998192 xiv Future Value of Cash Outflow -1870562 xv After Tax Salvage Value 433901.9 xvi Before Tax Salvage Value 767541.4

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