Another utilization of cash flow analysis is setting the bid price on a project.

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 152,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you%u2019ve decided to bid on the contract. It will cost you $1,920,000 to install the equipment necessary to start production; you%u2019ll depreciate this cost straight-line to zero over the project%u2019s life. You estimate that in five years this equipment can be salvaged for $162,000. Your fixed production costs will be $277,000 per year, and your variable production costs should be $9.70 per carton. You also need an initial investment in net working capital of $142,000. The tax rate is 34 percent and you require a 12 percent return on your investment. Assume that the price per carton is $17.20.

Calculate the project NPV. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Calculate the project NPV. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Revenue = 17.2 x 152,000 = 2614400$

Fixed cost = 277,000$

Variable cost = 9.7 x 152000 = 1474400$

Initial investment =$ 142000

Depreciation (per year ) = (1920000-162000)/5 = $351600

Cash Flow/ Income statement (for any year)

Revenue = $2614400

Variable cost = 1474400

Fixed cost = $ 277000

Depreciation = $351600

Profit beforew tax = $511400

Tax (@34%) = 173876

Profit after tax = $337524

Net cash flow = profit after tax + depreciation = $689124

NPV = -initial investment +CF1/(1+r)+CF2/(1+r)^2+CF3/(1+r)^3+CF4/(1+r)^4+CF5/(1+r)^5

= -142000+689124/1.12 +689124/1.12^2 .....+689124/1.12^5

=$2342137.79

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