Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2806550 • 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 141,000 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 $1,810,000 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 $151,000. Your fixed production costs will be $266,000 per year, and your variable production costs should be $8.60 per carton. You also need an initial investment in net working capital of $131,000. If your tax rate is 34 percent and you require a return of 13 percent on your investment, what bid price per carton should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
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 141,000 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 $1,810,000 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 $151,000. Your fixed production costs will be $266,000 per year, and your variable production costs should be $8.60 per carton. You also need an initial investment in net working capital of $131,000. If your tax rate is 34 percent and you require a return of 13 percent on your investment, what bid price per carton should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Depreciation = Investment / No. of years = 1,810,000 / 5 = 362,000
Cash Flows = Investment + NWC + Net Income + Depreciation + Salvage Value x (1 - tax rate)
NPV can be calculated using NPV function in excel or calculator
Using trial and error method, we need to find bid price such that NPV = 0
Bid Price = $13.87 at which NPV is almost equal to zero.
Guthrie 0 1 2 3 4 5 Investment -1,810,000 Salvage 151,000 NWC -131000 131000 Sales 1955726 1955726 1955726 1955726 1955726 VC -1212600 -1212600 -1212600 -1212600 -1212600 FC -266000 -266000 -266000 -266000 -266000 Depreciation -362000 -362000 -362000 -362000 -362000 EBT 115126.4 115126.4 115126.4 115126.4 115126.4 Tax (34%) -39143 -39143 -39143 -39143 -39143 Net Income 154269.4 154269.4 154269.4 154269.4 154269.4 Cash Flows -1,941,000 516269.4 516269.4 516269.4 516269.4 746929.4 NPV $31.80Related Questions
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