Dahlia Enterprises needs someone to supply it with 120,000 cartons of machine sc
ID: 2777402 • Letter: D
Question
Dahlia Enterprises needs someone to supply it with 120,000 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 $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 $70,000. Your fixed production costs will be $325,000 per year, and your variable production costs should be $10.30 per carton. You also need an initial investment in net working capital of $75,000. If your tax rate is 35 percent and you require a 12 percent return on your investment, what bid price should you submit? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 3
Explanation / Answer
At a price of $ 15.45 the project breaks even. Any price above this will be profitable. Given that bidder needs a return on investment of 12%, they can submit their bid at $ 17.30
working
No of Cartons required = 120,000 per annum
Period of Contract = 5 Years
Cost of Equipment = $ 870,000
Salvage Value after 5 years = $ 70,000
Initial Investment in networking capital = $ 75000
Required rate of Return = 12% or 0.12
Let A be the free cash inflows required to make NPV equals Zero (that is the project breaks-even)
-$ 870,000 - $ 75000 + A * [(1-(1/(1+r)^n)/r] + $ 70000/(1+r)^n = 0
A * [(1-(1/(1.12)^5)/0.12] + $ 70000/(1.12)^5 = $ 945000
A *[(1-(1/(1.7623417)/0.12] + $ 70000/1.7623417 = $ 945000
A * [(1-0.56743)/0.12] + $ 39719.88 = $ 945000
A * (0.43257/0.12) = $ 945000 - $ 39719.88
3.60475 * A = $ 905280.12
A = $ 905280.12/3.60475 = $ 251,135.34
A is the free Cash Flow required to make the project break-even
free Cash Flow = Income after Tax + Depreciation & Amortization
Let x be the sales price per Carton
Sales
120000 * x
120000*x
Variable Production Costs
120000 * 10.30
1,236,000
Fixed Production Costs
325,000
Depreciation
870000/5
174,000
Pre-tax cash flows
120000*x – 1,735,000
After Tax Cash flows
Tax rate = 35%
(120000*x – 1,735,000)*(1-0.35)
Free Cash Flows
(120000*x – 1,735,000)*0.65+174000
$ 251,135.34 = (120000*x – 1,735,000)*0.65+174000
$ 251,135.34 - $174,000 = 78000 * x – $ 1,127,750
78000 * x = $ 251,135.34 - $174,000 + $ 1,127,750
78000 * x = $ 1,204,885.34
x = $1,204,885.34 / 78,000 = $ 15.4472or $ 15.45 ( rounded off)
bid price at 12% required rate of return = $ 15.45 * 1.12 = $ 17.304 or $ 17.30 (rounded off)
Sales
120000 * x
120000*x
Variable Production Costs
120000 * 10.30
1,236,000
Fixed Production Costs
325,000
Depreciation
870000/5
174,000
Pre-tax cash flows
120000*x – 1,735,000
After Tax Cash flows
Tax rate = 35%
(120000*x – 1,735,000)*(1-0.35)
Free Cash Flows
(120000*x – 1,735,000)*0.65+174000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.