Dahlia Enterprises needs someone to supply it with 116,000 cartons of machine sc
ID: 2710465 • Letter: D
Question
Dahlia Enterprises needs someone to supply it with 116,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $830,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years, this equipment can be salvaged for $66,000. Your fixed production costs will be $321,000 per year, and your variable production costs should be $9.90 per carton. You also need an initial investment in net working capital of $71,000. If your tax rate is 34 percent and your required return is 10 percent on your investment, what bid price should you submit?
Answer should be close to 15.35!
Explanation / Answer
Cash Flows associated with contract Year 0 1 2 3 4 5 Initial Investment -830000 Initial working capital -71000 Salvage Value 66000 Total Cash Flows -901000 0 0 0 0 66000 Discount Rate 10% Discount factor (1/1.10^year) 1 0.90909091 0.826446 0.751315 0.683013 0.620921 Discounted Flows -901000 0 0 0 0 40980.81 Net Value -860019.1927 Discounted value of operating cash flows = total of discountng factors (for years 1-5) * x 3.790787 x At break-even level, the net value of the flows -860019.193 should be equal to 3.790787*x. That is x will be Annual Operating Cash flows x= 860019.193/3.790787 = 226870.90 Operating Cash flow can be calculated as follows Annual sale of cartons 116000 variable cost 9.9 Fixed costs 321000 Depreciation 830000/5 = 166000 Tax rate 34% Net Profit = Operating Cash flows - Depreciation = 226870.90-166000 = 60870.90 Net Sales =EBDIT+Fixed costs+Total Variable costs =258228.63+321000+1148400 1727628.63 Variable costs total cartons * variable cost 1148400.00 Fixed Costs 321000.00 EBDIT EBT + Depreciation 258228.63 Depreciation 166000.00 Earnings before tax net profit /(1-tax) 92228.63 Tax Net Profit 60870.90 To get an annual sale of 1727628.63, the sales price should be 1727628.63/116000 cartons = 14.89 In case the firm is looking for 10% mark up over this break-even price then the bid price would be 16.38 This above the is break-even price required by the company to make the net present value of the project equals to annual operating cash flows. They should be bidding above this rate
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