Romo Enterprises needs someone to supply it with 121,000 cartons of machine scre

Question

Romo Enterprises needs someone to supply it with 121,000 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 $880,000 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 $71,000. Your fixed production costs will be $326,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $76,000. If your tax rate is 30 percent and you require a return of 11 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

STEP 1:-

To find the bid price, we need to calculate all other cash flows for the project, and then solve for the bid price.

after- tax salvage value = $ 71000 ( 1-0.30) = $ 49700

Now, we calculate other cash flows(OCF) which will yield NPV = 0

NPV = -880000 - 76000 + OCF (PVIFA11%,5) + ( 49700 + 76000) / (1.11)5

0 = -956000 + OCF * 3.6959 + 125700 / 1.685

956000 - 74599.407 = OCF * 3.6959

OCF = $ 238480.639

STEP2: CALCULATE BID PRICE USING OTHER CASH FLOWS (let bid price be P)

238480.639 = { [ P - $10.40] * 121000 - 326000 } ( 1 - 0.30) + [880000/5]*0.30

238480.639 = 84700 * P -1109080+ 52800

P = $ 15.27

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