We have been requested by a large retailer to submit a bid for a new point-of-sale credit checking system. The system would be installed, by us, in 89 stores per year for three years. We would need to purchase $1,300,000 worth of specialized equipment. This will be depreciated at a 20 percent CCA rate. We will sell it in three years, at which time it will be worth about half of what we paid for it. Labour and material cost to install the system is about $96,000 per site. Finally, we need to invest $340,000 in working capital items. The relevant tax rate is 36 percent. What price per system should we bid if we require a 20 percent return on our investment? Try to avoid the winner's curse.

Question

We have been requested by a large retailer to submit a bid for a new point-of-sale credit checking system. The system would be installed, by us, in 89 stores per year for three years. We would need to purchase $1,300,000 worth of specialized equipment. This will be depreciated at a 20 percent CCA rate. We will sell it in three years, at which time it will be worth about half of what we paid for it. Labour and material cost to install the system is about $96,000 per site. Finally, we need to invest $340,000 in working capital items. The relevant tax rate is 36 percent. What price per system should we bid if we require a 20 percent return on our investment? Try to avoid the winner's curse.

Answer 1

To determine the price per system that you should bid, we need to calculate the total costs involved and then add the desired return on investment. Here's a step-by-step breakdown of the calculation:

1. Equipment Cost:
You would need to purchase $1,300,000 worth of specialized equipment. Since it will be depreciated at a 20 percent Capital Cost Allowance (CCA) rate, we can calculate the depreciation per year as follows:
Depreciation per year = Equipment cost * CCA rate = $1,300,000 * 20% = $260,000

2. Labor and Material Cost:
The labor and material cost to install the system is $96,000 per site. Since you will be installing the system in 89 stores per year for three years, the total labor and material cost would be:
Total labor and material cost = Cost per site * Number of stores per year * Number of years = $96,000 * 89 * 3 = $25,704,000

3. Working Capital Investment:
You need to invest $340,000 in working capital items.

4. Profit from Reselling Equipment:
After three years, you plan to sell the equipment for half of the original purchase price, which would be:
Resale value = Equipment cost / 2 = $1,300,000 / 2 = $650,000

5. Calculate the tax implications:
The relevant tax rate is 36 percent. To calculate the tax savings from depreciation, multiply the depreciation per year by the tax rate:
Tax savings from depreciation = Depreciation per year * Tax rate = $260,000 * 36% = $93,600

6. Calculate the total costs:
Total costs = Equipment cost + Labor and material cost + Working capital investment - Tax savings from depreciation + Resale value
Total costs = $1,300,000 + $25,704,000 + $340,000 - $93,600 + $650,000

7. Calculate the desired return on investment:
You mentioned that you require a 20 percent return on your investment.

8. Calculate the bid price per system:
Bid price per system = (Total costs + Desired return on investment) / Number of systems
Bid price per system = (Total costs + (Total costs * Desired return on investment)) / (Number of stores per year * Number of years)

Plug in the values to get the final bid price per system. Make sure to double-check the accuracy of the calculations and into account any additional expenses or considerations specific to your business.