Romo Enterprises needs someone to supply it with 121,000 cartons of machine scre
ID: 2778280 • Letter: R
Question
Romo Enterprises needs someone to supply it with 121,000 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 $880,000 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 $71,000. Your fixed production costs will be $326,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $76,000. 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
Minimum Bid Price should be NPV = 0
Initial Investment = Equipment + net working capital
Initial Investment = 880000 + 76000
Initial Investment = 956000
Terminal Cash Flow = Post tax salvage value + Working capital recovered
Terminal Cash Flow = 71000*(1-30%) + 76000
Terminal Cash Flow = $ 125700
Annual Cash Flow (at NPV =0 ) =( Initial Investment - Terminal Cash Flow*(1+r)^-n)/((1-(1+r)^-n)/r)
Annual Cash Flow (at NPV =0 ) = (956000- 125700*(1+11%)^-5)/((1-(1+11%)^-5)/11%)
Annual Cash Flow (at NPV =0 ) = $ 238,481.53
Annual Cash Flow = Bid Price*Quantity*(1-tax rate) - (variable production costs per unit * Quantity + Annual Fixed Cost)*(1-tax rate) + Annual Depreciation * tax rate
Annual Cash Flow = Bid Price*121000*(1-30%) - (10.40*121000 + 326000)*(1-30% + 880000/5 * 30%
Annual Cash Flow = 84700Bid Price - 1056280
84700Bid Price = Annual Cash Flow + 1056280
Bid Price = (Annual Cash Flow + 1056280)/84700
Bid Price = (238,481.53 + 1056280)/84700
Bid Price = $ 15.29
Answer
Bid Price = $ 15.29
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