2. Stephen and Cory, Inc., invites bids for supply of 200,000 units of widget li
ID: 2721734 • Letter: 2
Question
2. Stephen and Cory, Inc., invites bids for supply of 200,000 units of widget lids a year. You would like to bid on the contract. The plant manager believes that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only $1.50 a lid. The necessary machinery would cost $150,000. The investment could be written off using straight line method of depreciation to value of zero over a period of 5 years. Machine can be sold in the market at a price of $50,000 at the end of five years. There are no fixed costs. The plant manager estimates that the operation would require working capital of $30,000 but argues that this sum can be ignored since it is recoverable at the end of the 5 years. The company pays tax at a rate of 34 percent and the opportunity cost of capital is 15 percent. Determine the bid price for this contract. If Stephen and Cory do not want to pay more than $1.60 per unit, can you still supply them at that price?
Explanation / Answer
The NPV of the costs are calculated as follows to arrive at the bid price
So the bid price should be $1,254,889
If the price is $1.60, the total revenue that could be generated for 5 years with 200,000 widgets every year = 200,000* 5 * 1.6 = 1,600,000 which is higher than the bid price. Hence they should supply them at this price
Year 0 1 2 3 4 5 Initial Investment 150000 Working capital 30000 Cost of production 300000 300000 300000 300000 300000 Depreciation 30000 30000 30000 30000 30000 Total Costs 180000 330000 330000 330000 330000 330000 Salavage Value (after tax) -33000 Return of WC -30000 Net Costs 180000 330000 330000 330000 330000 267000 PV factor 15% 1 0.869565 0.756144 0.657516 0.571753 0.497177 PV of the costs 180000 286956.5 249527.4 216980.4 188678.6 132746.2 NPV 1254889Related Questions
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