Romo Enterprises needs someone to supply it with 112,000 cartons of machine scre

Question

Romo Enterprises needs someone to supply it with 112,000 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 $790,000 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 $62,000. Your fixed production costs will be $317,000 per year, and your variable production costs should be $9.50 per carton. You also need an initial investment in net working capital of $67,000. If your tax rate is 35 percent and you require a return of 12 percent on your investment, what bid price should you submit?

Explanation / Answer

The bid price should be set such that the NPV of the project is zero.

At bid price = 14.6044, we get NPV = 0

Romo 0 1 2 3 4 5 Investment -$790,000 NWC -$67,000 $67,000 Salvage $62,000 Sales $1,635,693 $1,635,693 $1,635,693 $1,635,693 $1,635,693 VC -$1,064,000 -$1,064,000 -$1,064,000 -$1,064,000 -$1,064,000 FC -$317,000 -$317,000 -$317,000 -$317,000 -$317,000 Depreciation -$158,000 -$158,000 -$158,000 -$158,000 -$158,000 EBT $96,693 $96,693 $96,693 $96,693 $96,693 Tax (35%) -$33,842 -$33,842 -$33,842 -$33,842 -$33,842 Net Profits $62,850 $62,850 $62,850 $62,850 $62,850 Cash Flows -$857,000 $220,850 $220,850 $220,850 $220,850 $328,150 NPV $0.88

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