Romo Enterprises needs someone to supply it with 111,000 cartons of machine scre

Question

Romo Enterprises needs someone to supply it with 111,000 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 $780,000 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 $61,000. Your fixed production costs will be $316,000 per year, and your variable production costs should be $9.40 per carton. You also need an initial investment in net working capital of $66,000. If your tax rate is 30 percent and you require a return of 11 percent on your investment, what bid price should you submit?

Explanation / Answer

Solution:

Let Sales price be X

In order to set minimum bid price,

Present value of cash inflows = present value out flows

CFAT + salvage value + working capital released = Initial cost + working capital introduced

3,6959*(77700X-904780) + 61000*0.5935 + 66000*0.5935 = 780000 + 66000

X = 14.33

Therefore minimum bid price will be $14.33/carton

Working Note:

Calculation of Cash flows after Tax(CFAT)

Sales 111000X

Less: V.Cost (111000*9.40) 1043400

Less: Fixed cost 316000

CFBT 111000X-1359400

CFAT = CFBT(1-Tax) + Tax savings on depreciation

= (111000X-1359400)(1 - 0.30) + (780000/5)*30%

= 77700X - 951580 + 46800

= 77700X-904780

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.