To solve the bid price problem presented in the text, we set the project NPV equ

Question

To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems. Romo Enterprises needs someone to supply it with 123,000 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 $900,000 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 $73,000. Your fixed production costs will be $328,000 per year, and your variable production costs should be $10.60 per carton. You also need an initial investment in net working capital of $78,000. Assume your tax rate is 35 percent and you require a 12 percent return on your investment.

a. Assuming that the price per carton is $17.30, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

b. Assuming that the price per carton is $17.30, find the quantity of cartons per year you need to supply to break even. (Do not round intermediate calculations and round your answer to nearest whole number.) Quantity of cartons

c. Assuming that the price per carton is $17.30, find the highest level of fixed costs you could afford each year and still break even. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Fixed costs

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Explanation / Answer

a) ROMO ENTERPRISES: ANNUAL OPERATING CASH FLOWS: # of cartons of machine screws to be supplied 123000 Sales at $17.30 per carton 2127900.00 Variable cost at $10.60 1303800.00 Fixed costs 328000.00 Depreciation (900000/5) 180000.00 NOI 316100.00 Tax at 35% 110635.00 NOPAT 205465.00 Add: Depreciation 180000.00 Annual OCF 385465.00 CALCULATION OF NPV: PV of OCF (Years 1 to 5) = 385465*PVIFA(12,5) = 385465*3.60478 = 1389516.52 PV of after tax salvage value = 73000*65%/1.12^5 = 26924.40 PV of recouped NWC = 78000/1.12^5 = 44259.29 PV of cash inflows 1460700.22 Less: Initial investment (900000+780000 NWC) 978000.00 NPV 482700.22 Answer b) For financial break even, the NPV should be 0 or PV of cash inflows should equal PV of cash outflows. Hence, 978000 = [q*(17.30-10.60)-328000]*0.65*PVIFA(12,5)+180000*0.35*PVIFA(12,5)+26924+44259 where q = the quantity for breaking even. Solving for q 978000-26924-44259-180000*0.35*3.60478 = (q*6.7)-328000)*0.65*3.60478 679716 +768539 = 15.6988169q q = (679716+768539)/15.6988169 = 92,252 cartons Answer CHECK: ANNUAL OPERATING CASH FLOWS: # of cartons of machine screws to be supplied 92252 Sales at $17.30 per carton 1595959.60 Variable cost at $10.60 977871.20 Fixed costs 328000.00 Depreciation (900000/5) 180000.00 NOI 110088.40 Tax at 35% 38530.94 NOPAT 71557.46 Add: Depreciation 180000.00 Annual OCF 251557.46 CALCULATION OF NPV: PV of OCF (Years 1 to 5) = 251557*PVIFA(12,5) = 251557*3.60478 = 906809.30 PV of after tax salvage value = 73000*65%/1.12^5 = 26924.40 PV of recouped NWC = 78000/1.12^5 = 44259.29 PV of cash inflows 977993.00 Less: Initial investment (900000+780000 NWC) 978000.00 NPV -7.00 ALMOST 0 c) For breaking even, the NPV should be zero. For 0 NPV, the fixed costs can increase by an amount equal to the Equivalent Annual NPV = 482700.22/PVIFA(12,5) = 482700.22/3.60478 = 133905.60 After tax Before tax = 133905.60/0.65 = 206008.61 Existing fixed cost 328000.00 Highest level of fixed costs that can be afforded to break even (financial break even) = 534008.61 Answer

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