You a working on a bid to build two city parks a year for the next three years.
ID: 2764935 • Letter: Y
Question
You a working on a bid to build two city parks a year for the next three years. This project requires the purchase of $150,000 of equipment that will be depreciated straight-line to zero value over the life of the project. The equipment can be sold at the end of the project for $30,000. You will also need $20,000 in net working capital for the duration of the project. The fixed costs will be $25,000 a year and the variable costs will be $100,000 per park. Your required rate of return is 15% and your tax rate is 35%. What is the minimal amount you should bid per park? Explain.
Explanation / Answer
Calculation of minimal amount to bid per park:
Year 0
Year 1
Year 2
Year 3
Cost of Equipment
$150,000.00
Less: Tax Saving on Depreciation :
Depreciation Per year = (Cost - Salvage value ) / Life
= (150000- 0) / 3 = 50000
Tax Saving on Depreciation = 50000*35% =
$ (17,500.00)
$ (17,500.00)
$ (17,500.00)
Less: Sale value of Equipment (Net of rax) = 30000* (1-35%)
$ (19,500.00)
Add: Net Working Capital Investment
$ 20,000.00
Less: Net Working Capital Release
$ (20,000.00)
Add: Fixed Costs (Net of Tax) = 25000* (1-35%)
$ 16,250.00
$ 16,250.00
$ 16,250.00
Add: Variable Costs (Net of Tax) = 100000*2* (1-35%)
$130,000.00
$130,000.00
$130,000.00
Net Cash Flows (CF)
$170,000.00
$128,750.00
$128,750.00
$ 89,250.00
PV of $ 1 (15%) (PVF)
1.00000
0.86957
0.75614
0.65752
Present value = CF*PVF
$170,000.00
$111,956.52
$ 97,353.50
$ 58,683.32
Minimum Bid = Sum of Present value (For two Parks)
$437,993.34
Minimum Bid per Park = 437993.34 / 2 =
$218,996.67
Calculation of minimal amount to bid per park:
Year 0
Year 1
Year 2
Year 3
Cost of Equipment
$150,000.00
Less: Tax Saving on Depreciation :
Depreciation Per year = (Cost - Salvage value ) / Life
= (150000- 0) / 3 = 50000
Tax Saving on Depreciation = 50000*35% =
$ (17,500.00)
$ (17,500.00)
$ (17,500.00)
Less: Sale value of Equipment (Net of rax) = 30000* (1-35%)
$ (19,500.00)
Add: Net Working Capital Investment
$ 20,000.00
Less: Net Working Capital Release
$ (20,000.00)
Add: Fixed Costs (Net of Tax) = 25000* (1-35%)
$ 16,250.00
$ 16,250.00
$ 16,250.00
Add: Variable Costs (Net of Tax) = 100000*2* (1-35%)
$130,000.00
$130,000.00
$130,000.00
Net Cash Flows (CF)
$170,000.00
$128,750.00
$128,750.00
$ 89,250.00
PV of $ 1 (15%) (PVF)
1.00000
0.86957
0.75614
0.65752
Present value = CF*PVF
$170,000.00
$111,956.52
$ 97,353.50
$ 58,683.32
Minimum Bid = Sum of Present value (For two Parks)
$437,993.34
Minimum Bid per Park = 437993.34 / 2 =
$218,996.67
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