Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2773329 • Letter: A
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 143,000 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 $1,830,000 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 $153,000. Your fixed production costs will be $268,000 per year, and your variable production costs should be $8.80 per carton. You also need an initial investment in net working capital of $133,000. If your tax rate is 38 percent and you require a 14 percent return on your investment, what bid price per carton should you submit?
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 143,000 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 $1,830,000 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 $153,000. Your fixed production costs will be $268,000 per year, and your variable production costs should be $8.80 per carton. You also need an initial investment in net working capital of $133,000. If your tax rate is 38 percent and you require a 14 percent return on your investment, what bid price per carton should you submit?
Explanation / Answer
Answer:
ATSV = .62 x 153000 =$94860
To find the needed OCF to break even, use your calculator with n=5, PV=-1963000
FV=227860, r=14%, and solve for PMT. You should get OCF = PMT =$537318.13
Now, using
OCF = (Sales - Costs) x (1 - T) + Depr x T
Depr = 1830,000 / 5 = 366,000
Costs = FC + VC x Q = 268,000 + 8.8 x 143,000 = 1,526400
solve for sales:
Sales = ( OCF - Depr x T + Costs x (1 - T) ) / (1 - T)
=($537318.13-366,000*0.38+1,526400*(1-0.38))/0.62
=($398238.13+946368)/0.62
=2168719.56
Or, 2168719.56/ 143,000 = 15.17 per box.
Particulars 0 1 2 3 4 5 OCF NCS -1830000 94860 Ch NWC -133000 133000 CFFA -1963000 227860Related Questions
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