To solve the bid price problem presented in the text, we set the project NPV equ

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 123,000 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 $900,000 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 $73,000. Your fixed production costs will be $328,000 per year, and your variable production costs should be $10.60 per carton. You also need an initial investment in net working capital of $78,000. 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 $17.30, what is the NPV of this project?

Assuming that the price per carton is $17.30, find the quantity of cartons per year you need to supply to break even.

Assuming that the price per carton is $17.30, find the highest level of fixed costs you could afford each year and still break even.

b.

Assuming that the price per carton is $17.30, find the quantity of cartons per year you need to supply to break even.

c.

Assuming that the price per carton is $17.30, find the highest level of fixed costs you could afford each year and still break even.

Explanation / Answer

Initial outlay = FCinv + WCinv
Here the cost of equipment is $900,000 and net working capital will increase by $77,000
Thus,
Initial outlay = FCinv + WCinv
=900000+78000
=978000

Depreciation is based on SLM with salvage value of 72000 in 5 years
Thus depreciation per year = 900000-73000 / 5 = 165400

Sales = price per carton * no of carton = 17.30*123000 = 2127900
varibale cosst = varibal cost per carton * no of carton = 10.60*123000 = 1303800
Fixed cost = 328000 and tax = 35%
After tax operating cash flow = (sales-cost-depreciation)*(1-tax)+depreciation
=(2127900-1303800-328000-165400)*(1-0.35) + 165400
=380355

Terminal year cashflow = salvage + WCinv - Tax*(salvage-book value)
=73000+78000 - 0.35*(73000-0)
=151000 - 25550
=125450
(and this will get added to final year ie year 5 cashflow and it will be 125450+380355=505805)

Answer a. NPV calculation at 12% cost of investment is as below:

Years

Cashflow

0

-978000

1

380355

2

380355

3

380355

4

380355

5

505805

NPV at 12%

$414,534.24

answer b. The fixed cost per year = 328000
and sales - variable cost = 17.30 - 10.60 = 6.7

And thus breakeven cartons needed per year = 328000 / 6.7 = 48955


answer c. Sales = price per carton * no of carton = 17.30*123000 = 2127900
varibale cosst = varibal cost per carton * no of carton = 10.60*123000 = 1303800

Thus the highest level of fixed cost that can be afforded = 2127900 - 1303800 = 824100 per year.

Years

Cashflow

0

-978000

1

380355

2

380355

3

380355

4

380355

5

505805

NPV at 12%

$414,534.24

You can also calculate NPV in your financial calculator by inserting all the respective cashflows and by pressing CPT and then NPV at 12%

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