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 Sheetbend 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 Sheetbend to a fixed-price, long-term ...view middle of the document...
Table 9-4 shows the sales staff's forecasts 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% of 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 from Sheetbend's CEO. It contained a firm offer from a Maine 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 proposed price of $30 per yard? The discount rate for this project is 12%.
Part Two Value
Year: 1 2 3 4 5
1. Yards sold 100.00 100.00 100.00 100.00 100.00
2. Price per yard 30.00 30.00 30.00 30.00 30.00
3. Revenue (1 ?? 2) 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00
4. Cost of goods sold 2,100.00 2,184.00 2,271.36 2,362.21 2,456.70
5. Operating cash flow (3 ?? 4) 900.00 816.00 728.64 637.79 543.30
6. Depreciation 250.00 250.00 250.00 250.00 250.00
7. Income (5 ?? 6) 650.00 566.00 478.64 387.79 293.30
8. Tax at 35% 227.50 198.10 167.52 135.72 102.65
9. Net income (7 ?? 8) $422.50 $367.90 $311.12 $252.07 $190.65
TABLE 9-4 Forecast income statement for the U.S. Navy duffel canvas project (dollar figures in thousands, except price per yard)
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 variable costs 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 is depreciated straight-line over 5 years ($200,000 per year). The $500,000 cost of refurbishing the Pleasantboro plant is depreciated straight-line over 10 years ($50,000 per year).
Should Mr. Tar recommend submitting the bid to the navy at the proposed price of $30 per year? Or should Mr.Tar recommend the company pursue it's next best alternative? Please prepare a memo to Sheetbend's CEO with a recommendation providing supporting information on all aspects of your analysis.
The spreadsheet on the next page shows the cash flows associated with the project.
Rows 1 – 10 replicate the data in Table 9-4, with the exception of the substitution of MACRS depreciation for straight-line depreciation.
Row 12 (capital investment) shows the initial investment of $1.5 million in refurbishing the plant and buying the new machinery.
When the project is shut down after five years, the machinery and plant will be worthless. But they will not be fully depreciated. The tax loss on each will equal the book value since the market price of each asset is zero. Therefore, tax savings in...