See attached file.
Jack Tar, CFO of Sheetbend & Halyard, Inc. opened the company confidential envelope. It contained a draft of a competitive bid for a contract to supply duffel canvas to the U.S. Navy. The cover memo from Sheetbend´s CEO asked Mr. Tar to review the bid before it was submitted.
The bid and its supporting documents had been prepared by Sheetbend´s sales staff. It called for Sheet bend to supply 100,000 yards of duffel canvas per year for 5 years. The proposed selling price was fixed at $30 per yard.
Mr. Tar was not usually involved in sales, but this bid was unusual in at least two respects. First, if accepted by the Navy, it would commit Sheet bend to a fixed-price, long-term contract. Second, producing the duffel canvas would require an investment of 1.5 million to purchase machinery and to refurbish Sheetbend's plant in Pleasantboro, Maine.
Mr. Tar set to work and by the end of the week had collected the following facts and assumptions:
The plant in Pleasantboro had been built in the early 1900s and is now idle. The plant was fully depreciated on Sheetbend´s books except for the purchase cost of the land (in 1947) of $10 000.
Now that the land was valuable shorefront property. Mr. Tar thought the land and the idle plant could be sold, immediately or in the near future, for $600,000.
Refurbishing the plant would cost $500,000. This investment would be depreciated for tax purposes on the 10 year MACRS schedule.
The new machinery would cost $1 million. This investment could be depreciated on the 5 year MACRS schedule.
The refurbished plant and new machinery would last for many years. However, the remaining market for duffel canvas vas small, and it was not clear that additional orders could be obtained once the navy contract was finished. The machinery was custom-build and could be used only for duffel canvas. Its secondhand value at the end of 5 years was probably zero.
Table show the sales staff`s forecast of income from the navy contract. Mr. Tar reviewed this forecast and decided that its assumptions were reasonable, except that the forecast used book, not tax depreciation.
But the forecast income statement contained no mention of working capital. Mr. Tar thought that working capital would average about 10% sales.
Armed with this information, Mr. Tar constructed a spreadsheet to calculate the NPV of the duffel canvas project, assuming that Sheetbend's bid would be accepted by the navy.
He had just finished debugging the spreadsheet when another confidential envelope arrived form Sheetbend`s CEO. It contained a firm offer from a Maui real estate developer to purchase Sheetbend`s Pleasantboro land and plant for $1.5 million in cash.
Should Mr. Tar recommend submitting the bid to the navy at the propose price of $30 per yard? The discount rate for this project is 12%.
1. Yards sold and price per yard would be fixed by contract.
2. Cost of goods includes fixed cost of $300,000 per year plus variables cost of $18 per yard. Costs are expected to increase at the inflation rate of 4% per year
3. Depreciation: A $1 million investment in machinery la depreciated straight-line over 5 years $200,000 per year. The $500,000 cost of refurbishing the Pleasantboro plants is depreciated straight-line over 10 years $50,000 per year.
Must first take into account the table on page 282 to build and calculate present values.
Once you have it in Excel should calculate MACRS depreciation for the percentage for each of the 5 years and replace the one that comes in the table above.
Calculate the depreciation of machinery and plant separately. Once you get the new MACRS depreciation calculated the result will be net income.
Following this step will get the cash flow from operations is calculated by subtracting total operating cash flow chart indicating the less the recalculation of tax of 35%.
Now here we have the operating cash flow and we need to get the total cash flow for the year 5 for this, consider the following:
When the project is closed after five years, the plant and machinery will be useless. But it will not be fully depreciated. The tax loss for each of them is equal to book value and market price of each asset is zero. Therefore, it is the same tax savings in year 5.
Investment in working capital equivalent to $ 300,000 initially, (10% of sales) but in year 5, when the project closes, the investment in working capital is recovered. If the project goes ahead, the land cannot be sold until the end of year 5. If the land is sold for $ 600,000 (as Mr. Tar revenue can be), the taxable gain on the sale is $ 590,000, since the land has a book value of $ 10,000.
With this information and can calculate the cash flow considering the sale of land tax rate of 35%. Also add all the depreciation of machinery and plant and calculate the tax of 35% as well.
Since this information can get the total cash flow.
The following is to calculate the present value of cash flow considering a discount rate of 12%.
The solution discuses if Sheetbend and Halyard should accept the contract with the U.S. Navy.