Romo Enterprises needs someone to supply it with 118,000 cartons of machine scre

Question

Romo Enterprises needs someone to supply it with 118,000 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 $850,000 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 $68,000. Your fixed production costs will be $323,000 per year, and your variable production costs should be $10.10 per carton. You also need an initial investment in net working capital of $73,000. If your tax rate is 35 percent and you require a return of 12 percent on your investment, what bid price should you submit?

Explanation / Answer

Let bid price be $X

Cash outflows = $850000 + $73000 = $923000

Cash inflows per year = [118000(X-10.10) - 323000] (1-0.35) + [850000/5]x0.35

= [118000X - 334800] x (1-0.35) + [170000x0.35]

= 76700X - 217620 + 59500

= 76700X - 158120

Present Value = [76700X - 158120] x 3.604...

= 276486.33X - 569987.21

Scarp and reversal of working capital at year 5 = 68000(1-0.35) + 73000

= 44200 + 73000

= $117200

Present value = 117200 x 0.567....

= $66502.43

Present value of cash inflows = 276486.33X - 569987.21 + 66502.43

= 276486.33X - 503484.78

Present value of cash inflows = Present value of cash outflows

276486.33X - 503484.78 = 923000

X = $5.16

Bid price to be submitted = $5.16

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