You are working on a bid to build two apartment buildings a year for the next three years. This project requires the purchase of $847,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. Ignore bonus depreciation. The equipment can be sold at the end of the project for $415,000. You will also need $165,000 in net working capital over the life of the project. The fixed costs will be $528,000 a year and the variable costs will be $1,640,000 per building. Your required rate of return is 16 percent for this project and your tax rate is 24 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building?
A) $4,158,400
B) $4,489,500
C) $2,065,700
D) $2,780,600
E) $2,244,800

Question

Quizplus · Accepted Answer

To find the minimal bid per building, we first calculate the project's cash flows, including the initial investment, operating cash flows, and terminal cash flows, and then use the required rate of return to find the present value of these cash flows. The initial investment includes the purchase of equipment and the need for net working capital. The operating cash flows are influenced by the revenue from the bids, the fixed and variable costs, depreciation, and taxes. The terminal cash flow includes the salvage value of the equipment and the recovery of net working capital. The depreciation is calculated using straight-line depreciation over three years, which affects the project's taxable income and thus the taxes paid. The minimal bid per building must cover all these costs and provide the required return on investment.

You Are Working on a Bid to Build Two Apartment