Romo Enterprises needs someone to supply it with 127,000 cartons of machine scre
ID: 2762524 • Letter: R
Question
Romo Enterprises needs someone to supply it with 127,000 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 $940,000 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 $77,000. Your fixed production costs will be $332,000 per year, and your variable production costs should be $11.00 per carton. You also need an initial investment in net working capital of $82,000. If your tax rate is 30 percent and you require a return of 11 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Romo Enterprises needs someone to supply it with 127,000 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 $940,000 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 $77,000. Your fixed production costs will be $332,000 per year, and your variable production costs should be $11.00 per carton. You also need an initial investment in net working capital of $82,000. If your tax rate is 30 percent and you require a return of 11 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
GIVEN
EQUIPMENT COST: $940,000
SALVAGE VAUE AFTER 5 YEARS : $77000
SO DEPRICIATION PER YEAR WILL BE =$940000-$77000/5=$172600
AND TAX RATE IS 30% SO THERE WILL BE SAVING OF TAX ON DEPRICIATION PORTION
WHICH WILL BE = $172600*30%=$51780 PER YEAR
WORKING CAPITAL REQUIREMENT = $82000
AND VARIABLE COST REQUIREMENT = $11*127000=$1397000
SAVINGS OF TAX IN VARIABLE COST AND WORKING CAPITAL = ($1397000+$82000)*30%=$443700
TOTAL CASH OUTFLOW = $940000+$82000+$139700=$2419000
AND SAVINGS IN TAX WILL BE = $443700+($51780*5)# = $702600
# THERE WILL BE SAVINGS IN TAX FOR 5 YEARS
NET CASH OUTFLOW ( AFTER CONSIDERING SAVINGS IN TAX) =$2419000-$702600=$1716400
RETURN OF RETURN =11%
SO BID PRICE WILL BE = $1716400*11% = $188804
SO PER CARTON BID PRICE WILL BE =$188804/127000 =$1.4866
ANSWER = $1.49
TUTORIAL NOTE : FIXED COST WILL NOT FORM PART OF THE DECISION IN FINDING BID PRICE
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