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 125,000 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 $920,000 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 $75,000. Your fixed production costs will be $330,000 per year, and your variable production costs should be $10.80 per carton. You also need an initial investment in net working capital of $80,000. Assume your tax rate is 34 percent and you require a 10 percent return on your investment. . 1.Assuming that the price per carton is $17.50, what is the NPV of this project? 2.Assuming that the price per carton is $17.50, find the quantity of cartons per year you need to supply to break even. 3. Assuming that the price per carton is $17.50, find the highest level of fixed costs you could afford each year and still break even.

Explanation / Answer

Answer: Step1: let me first explain the formulas used in here

Depreciation amount : euipement cost - salvage value/ no of years of equipment used

Present value = cash flow/ ( 1 + interest rate) ^ ( no of years)

Sales revenue = Unit sales price * NO of units

Variable cost = VC per unit * no of units

NPV of the project is coming out to be $518278.2

Answer 2: using Break even equation

No of units * unit sales price = fixed cost + VC per unit * No of units

Lets say no of units is X

X*17.5 = 330000 + X*10.8

6.7*X = 330000

X = 330000/6.7 = 49253.73 or 49254 is the break even value

Answer 3: Using the same equation:

17.50 * 125000 = fixed cost + 10.8 * 125000

max fixed cost for break even = $837500

0 1 2 3 4 5 UNIT PRICE 17.5 cost of equipment 920000 Sales revenue 2187500 2187500 2187500 2187500 2187500 Fixed production cost 330000 330000 330000 330000 330000 Varibale production cost 1350000 1350000 1350000 1350000 1350000 Salvage value 75000 Net working capital 80000 net cash inflow/outflow 1000000 507500 507500 507500 507500 582500 Depreciation 169000 169000 169000 169000 169000 Tax(34%) 0 115090 115090 115090 115090 140590 Net cash flow after tax and adding back depreciation -1000000 392410 392410 392410 392410 441910 Present value -1000000 356736.4 324305.8 294823.4 268021.3 274391.3 NPV 518278.2

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