Another utilization of cash flow analysis is setting the bid price on a project.

Question

Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 147,000 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 $1,870,000 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 $157,000. Your fixed production costs will be $272,000 per year, and your variable production costs should be $9.20 per carton. You also need an initial investment in net working capital of $137,000. The tax rate is 38 percent and you require a 13 percent return on your investment. Assume that the price per carton is $16.70.

Explanation / Answer

NPV at Sale price $16.70 Equipment Solvage Working Sales Variable Net Operating Net Year Cost Value Capital in $ Fixed Cost Cost Depreciation Income Tax @38% EAT Cashflow Cashflows 0 -1870000 -137000 -2007000 1 2454900 -272000 -1352400 -342600 487900 -185402 302498 645098 645098 2 2454900 -272000 -1352400 -342600 487900 -185402 302498 645098 645098 3 2454900 -272000 -1352400 -342600 487900 -185402 302498 645098 645098 4 2454900 -272000 -1352400 -342600 487900 -185402 302498 645098 645098 5 157000 2454900 -272000 -1352400 -342600 487900 -185402 302498 645098 802098 EAT = Net income - Tax Operating cashflows = EAT+Depreciation Net Cashflows = Equipment cost+solvage + working capital Present Year Cashflows pv factor at 13% Value 0 -2007000 1 -2007000 1 645098 0.8849558 570883.19 2 645098 0.7831467 505206.36 3 645098 0.6930502 447085.27 4 645098 0.6133187 395650.68 5 802098 0.5427599 435346.66 Total 347172.16 When Net present value is Zero price is 15.61698 Equipment Solvage Working Sales Variable Net Operating Net Year Cost Value Capital in $ Fixed Cost Cost Depreciation Income Tax @38% EAT Cashflow Cashflows 0 -1870000 -137000 -2007000 1 2295697 -272000 -1352400 -342600 328696.6 -124905 203791.9 546391.9 546391.9 2 2295697 -272000 -1352400 -342600 328696.6 -124905 203791.9 546391.9 546391.9 3 2295697 -272000 -1352400 -342600 328696.6 -124905 203791.9 546391.9 546391.9 4 2295697 -272000 -1352400 -342600 328696.6 -124905 203791.9 546391.9 546391.9 5 157000 2295697 -272000 -1352400 -342600 328696.6 -124905 203791.9 546391.9 703391.9 EAT = Net income - Tax Operating cashflows = EAT+Depreciation Net Cashflows = Equipment cost+solvage + working capital Present Year Cashflows pv factor at 13% Value 0 -2007000 1 -2007000 1 546391.9 0.8849558 483532.67 2 546391.9 0.7831467 427905.01 3 546391.9 0.6930502 378677 4 546391.9 0.6133187 335112.39 5 703391.9 0.5427599 381772.95 Total 0.03 So Break even price is $15.62

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