To solve the bid price problem presented in the text, we set the project NPV equ
ID: 2791415 • Letter: T
Question
To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems.
Romo Enterprises needs someone to supply it with 115,000 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 $820,000 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 $65,000. Your fixed production costs will be $320,000 per year, and your variable production costs should be $9.80 per carton. You also need an initial investment in net working capital of $70,000. Assume your tax rate is 35 percent and you require a 12 percent return on your investment.
Assuming that the price per carton is $16.50, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Assuming that the price per carton is $16.50, find the quantity of cartons per year you need to supply to break even. (Do not round intermediate calculations and round your answer to nearest whole number.)
Assuming that the price per carton is $16.50, find the highest level of fixed costs you could afford each year and still break even. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems.
Romo Enterprises needs someone to supply it with 115,000 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 $820,000 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 $65,000. Your fixed production costs will be $320,000 per year, and your variable production costs should be $9.80 per carton. You also need an initial investment in net working capital of $70,000. Assume your tax rate is 35 percent and you require a 12 percent return on your investment.
a.Assuming that the price per carton is $16.50, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
NPV $
b.
Assuming that the price per carton is $16.50, find the quantity of cartons per year you need to supply to break even. (Do not round intermediate calculations and round your answer to nearest whole number.)
Quantity of cartons
c.
Assuming that the price per carton is $16.50, find the highest level of fixed costs you could afford each year and still break even. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Fixed costs $
Explanation / Answer
Answer a. The intital installation for necessary equipment is 820,000 and the incraese in working capital is 70,000
Thus the initial outlay = FCinv + WCinv
=820000+70000
=890000
Depreciation for 5 years and salvage value of 65000
Thus per year depreciation = 820000-65000 / 5
= 755000 / 5
= 151,000
After tax operating cashflow = (sales-cost-depreciation)*(1-tax)+Depreciation
Sales = 16.5*115000 = 1897500
Cost = 320000 + 9.8*115000 = 1447000
Depreciation = 151000
Tax = 35%
thus,
ATOCF = (1897500-1447000-151000)*(1-0.35)+151000
= 345675
Terminal year cashflow = salvage + WCinv - tax*(Salvage-bookvalue)
=65000+70000 - 0.35*(65000-0)
=135000 - 22750
= 1,12,250
(and this will be added to final year 5 Cashflow thus it will be 112250+345675 = 457925)
NPV at 12% require rate is calculated as below:
Year
cashflow
0
-890000
1
345675
2
345675
3
345675
4
345675
5
457925
NPV at 12%
$374,798.82
Answer b.
The price of carton = 16.50
and variable cost = 9.80
thus 16.50-9.80 = 6.70
and fixed cost = 320000
so number of cartons to be sold to break even = 320000 / 6.7 = 47,761.19
Answer c.
as calculated in answer B the breakeven quantity is less than quantity sold per year.
Thus the maximum fixed cost one could afford = (16.5-9.80)*115000 = 770,500
Year
cashflow
0
-890000
1
345675
2
345675
3
345675
4
345675
5
457925
NPV at 12%
$374,798.82
You can also calculate NPV by inserting respective cashflows in your financial calculator and by pressing CPT and then 12% and NPVRelated Questions
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