Reference no: EM13305336

Snake Farm Inc. (SFI) has been offered to submit a competitive bid for building 31 and 22, 18, and 11offshore pits per year for Athletic Inc. over the next four years. If the bid is accepted, SFI will be also construct 49, 51, 27, and 13 offshore pits per year for the next four year for other clients at a guaranteed price of $153 million per pit. SFI will be spending $2,400M in new capital spending in order to build these pits. Each pit costs $72 million in materials. To run the facilities in which the pits are going to be built, SFI has to spend $1,100M annually in fixed costs. SFI needs to increase its net working capital initially by $701M and every year after with 15% of the next year's change in sales. SFI can sell the facilities and equipment for $700M in four years. SFI uses an accelerated depreciation method which has the following schedule: Year 1, 16%Year 2, 44%; Year 3, 26%; Year 4, 9%; Year 5, 6%. SFI's cost of capital is 20%. SFI has a hurdle IRR rate of 30% to accept any new projects. SFI's tax rate is 45%. SFI's WACC is 20%. SFI would set up a separate corporate entity to do this project and thus there are no subsidizations across divisions. Income tax is treated differently from the capital gain/loss taxes.

A. What is the lowest bid that SFI can make without violating the capital budgeting criterion for accepting new projects, if there are no tax-loss-carry provisions?
B. Determine what would be lowest bid that SFI can make without violating the capital budgeting criterion for accepting new projects, IF (1) the depreciation method is changed to straight-line (for 4 years with zero accounting salvage value) and (2) there exist a carry forward (indefinitely in future) tax loss provision?