Central Valley Home needs someone to supply them with 30,000 cartons of machine

Question

Central Valley Home needs someone to supply them with 30,000 cartons of machine screws to support their construction needs over the next five years, and you have decided to bid on the contract. It will cost you $250,000 to install the necessary equipment to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimated that in five years this equipment can be salvaged for $20,000. Your fixed production costs will be $75,000 per year, and your variable cost will be $5 per carton. You also need an initial investment in net working capital of $120,000 to start the project. If your tax rate is 30% and you require a 10% return on your investment, what bid price will you submit?

Explanation / Answer

Year/Description of cash flow 0 1 2 3 4 5 Cost of equipment (A) -250000 Variable Cost=(30000/5)*5 (B) -30000 -30000 -30000 -30000 -30000 Fixed Cost © -75000 -75000 -75000 -75000 -75000 Net Working Capital (D) -120000 120000 Tax shield on depriciation=0.30*250000/5 (E) 15000 15000 15000 15000 15000 Salvage Value after tax=20000*(1-0.30) (F) 14000 Cash flow=A+B+C+D+E+F -370000 -90000 -90000 -90000 -90000 44000 Discounted cash flow@10% -370000 -81818.2 -74380.2 -67618.3 -61471.2 27320.54 Net cash flow -627967 Considering that the 30000 cartoons of machine screw will be supplied in equal quantity over a period of 5 years , we should quote a bid price of 627967

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