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. T project. This type of analysis can be extended to many other types of problems hus the bid price represents a financial break-even level for the Romo Enterprises needs someone to supply it with 119,000 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 $860,000 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 $69,000. Your fixed production costs will be $324,000 per year, and your variable production costs should be $10.20 per carton. You also need an initial investment in net working capital of $74,000. Assume your tax rate is 34 percent and you require a 10 percent return on your investment. a. Assuming that the price per carton is $16.90, 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 $16.90, 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 $16.90, 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

Explanation / Answer

a) Initial Investment = 860000 + 74000 = 934000

Depreciation = (860000-69000)/5 = 158200

Earnings per year = 119000(16.9-10.2) - 324000 - 158200 = 315100

Earnings after tax = 315100 - 315100*34% = 207966

Cash flows after tax = Earnings after tax + non cash expenses = 207966 + 158200 = 366166

Annuity factor for 10% for 5 yeras = 3.7908

Therefore, present value of inflows = (366166*3.7908) + (69000*0.6209) = 1430900.8

Therefore NPV = 1430900.8 - 934000 = 496900.8

b) Let x be the number of cartons.

Earnings per year = x(16.9-10.2) - 324000 - 158200 = 6.7x-482200

Earnings after tax = (6.7x-482200) - (6.7x-482200)*34%

Cash flows = [((6.7x-482200) - (6.7x-482200)*34%)] + 158200

Present value of cash flows and salvage value = Initial investment

=>  {[((6.7x-482200) - (6.7x-482200)*34%)] + 158200}*3.7909 + 69000*0.6209 = 934000

=> (6.7x-482200) - (6.7x-482200)*34%) = 76884.82

=> 6.7x -482200 - 2.278x + 163948 = 76884.82

=> x = 89357.04

c) Let fixed costs be x

Earnings every year = 119000(16.9-10.2) - x - 158200 = 639100 - x

Earnings after tax = (639100-x) - (639100-x)34% = 639100-x-217294+0.34x = 421806-0.66x

Cash flows = 421806-0.66x+158200 = 580006-0.66x

Present value of cash flows = Initial investment

=> (580006-0.66x)*3.7908 + 69000*0.6209 = 934000

=> 2198679 - 2.502x + 42843.57 = 934000

=> x = 522608

Therefore, the highest level of fixed cost = 522608.

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