299 The bid process involves determining the price for which the NPV of the

299 the bid process involves determining the price

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299. The bid process involves determining the price for which the NPV of the project is zero (or some alternative minimum NPV level acceptable to the firm). In setting a bid price, a manager typically forecasts all relevant cash outflows and inflows exclusive of revenues. Then, the manager determines the level of OCF that will make NPV just equal to zero. Finally, the manager works backwards up through the statement of comprehensive income to determine the bid price that results in the desired level of OCF. The ultimate objective here is to determine the price at which the firm just reaches its financial breakeven point. Each bidding firm usually arrives at a different calculated bid price because they may use different assumptions in the evaluation process, such as the estimated time to complete the project, costs and quality of the materials used, estimated labour costs, the required rate of return, and so on.300. Essentially, the firms may use different assumptions in any stage of the evaluation process including estimated time to complete the building, costs and quality of materials used as an input, estimated labour costs, and the required rate of return. This question essentially asks students how it is that two firms come up with the necessary inputs for their project analysis.301. If the disposing of the asset terminates its CCA pool, after-tax salvage value = selling price - (selling price - book value)(tax rate). If the CCA pool continues, after tax salvage value = selling price -( selling price - book value)(CCA rate)(tax rate)/(CCA rate + discount rate). This value should be included in the analysis as it is an incremental and relevant cash flow.Assuming the end result will be a reduction in costs, in present value terms, may be erroneous. There may be a better alternative to the project being considered and the analysis will help identify which alternative is best, especially when some alternatives have different project lives.302. Student answers will vary but two key points that should be presented are:303. A cost-cutting project produces no revenue while an income-producing project does. A cost-cutting project has negative costs as opposed to the positive costs of an income-producing project. Other than that, the statement of comprehensive incomes are computed the same and can result in either a positive or a negative net income.304. Depreciation lowers both the taxable income and the net income of a project. Depreciation increases the operating cash flow because depreciation shields income from taxation thereby lowering the cash outflow for taxes.
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Chapter 10_Making Capital Investment Decisions SummaryCategory# of QuestionsDifficulty: Basic201Difficulty: Challenge8Difficulty: Intermediate95Learning Objective: 10-01 How to determine relevant cash flows for a proposed project.144Learning Objective: 10-02 How to project cash flows and determine if a project is acceptable.44Learning Objective: 10-03 How to calculate operating cash flow using alternative methods.30
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