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. Martin Enterprises needs someone to supply it with 137,000 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 $970,000 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 $121,000. Your fixed production costs will be $545,000 per year, and your variable production costs should be $18.55 per carton. You also need an initial investment in net working capital of $114,000. Assume your tax rate is 22 percent and you require a return of 12 percent on your investment. a. Assuming that the price per carton is $28.40, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. Assuming that the price per carton is $28.40, find the quantity of cartons per year you can supply and still break even. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) c. Assuming that the price per carton is $28.40, find the highest level of fixed costs you could afford each year and still break even.

Light emitting diode (LED) light bulbs have become required in recent years, but do they make financial sense? Suppose a typical 60-watt incandescent light bulb costs $.50 and lasts for 1,000 hours. A 15-watt LED, which provides the same light, costs $3.65 and lasts for 12,000 hours. A kilowatt-hour is 1,000 watts for 1 hour. Suppose you have a residence with a lot of incandescent bulbs that are used on average 500 hours a year. The average bulb will be about halfway through its life, so it will have 500 hours remaining (and you can’t tell which bulbs are older or newer).

If you require a return of 9 percent, at what cost per kilowatt-hour does it make sense to replace your incandescent bulbs today?

Letang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $300,000, has a four-year life, and requires $101,000 in pretax annual operating costs. System B costs $380,000, has a six-year life, and requires $95,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. The tax rate is 22 percent and the discount rate is 10 percent.

Calculate the NPV for both conveyor belt systems.

Answer 1

	Order units	1,37,000
	Year	0	1	2	3	4	5	5	Total
	Cash outflow
	Machine	9,70,000.00
	Working Capital	1,14,000.00						1,14,000.00
	Salvage							1,21,000.00
	Tax At 22% on salvage							26,620.00
	Sales		38,90,800.00	38,90,800.00	38,90,800.00	38,90,800.00	38,90,800.00
	Variable cost		25,41,350.00	25,41,350.00	25,41,350.00	25,41,350.00	25,41,350.00
	Contribution		13,49,450.00	13,49,450.00	13,49,450.00	13,49,450.00	13,49,450.00
	Fixed cost		5,45,000.00	5,45,000.00	5,45,000.00	5,45,000.00	5,45,000.00
	Profit before depreciation		8,04,450.00	8,04,450.00	8,04,450.00	8,04,450.00	8,04,450.00
	Depreciation		1,94,000.00	1,94,000.00	1,94,000.00	1,94,000.00	1,94,000.00
	Profit after depreciation		6,10,450.00	6,10,450.00	6,10,450.00	6,10,450.00	6,10,450.00
	Tax At 22%		1,34,299.00	1,34,299.00	1,34,299.00	1,34,299.00	1,34,299.00
	PAT		4,76,151.00	4,76,151.00	4,76,151.00	4,76,151.00	4,76,151.00
	Depreciation		1,94,000.00	1,94,000.00	1,94,000.00	1,94,000.00	1,94,000.00
	Cash inflow from operation		6,70,151.00	6,70,151.00	6,70,151.00	6,70,151.00	6,70,151.00
	Net Cash Inflow	-10,84,000.00	6,70,151.00	6,70,151.00	6,70,151.00	6,70,151.00	6,70,151.00	2,08,380.00	24,75,135.00
	PVIF AT 12%	1	0.892857143	0.797193878	0.711780248	0.635518078	0.567426856	0.567426856
	Present value	-10,84,000.00	5,98,349.11	5,34,240.27	4,77,000.24	4,25,893.08	3,80,261.67	1,18,240.41	14,49,984.78
a.	NPV	14,49,984.78
b.	Break even units
	sale price	28.4
	Variable cost	18.55
	Contribution	9.85
	PV ratio	35%
	Break even units =	Fixed cost / contribution per unit
		55,329.95
	Break even in value =	Fixed cost / PV ratio
		15,71,370.56
c.	Contribution per unit	9.85
	Total contribution	units*9.85
	Total contribution	13,49,450.00
	highest level of fixed costs you could afford each year and still break even.	13,49,450.00

Particulars	System A	System B
Cost	3,00,000.00	3,80,000.00
Life	4.00	6.00
Depreciation	75,000.00	63,333.33
operating cost	1,01,000.00	95,000.00
Tax savings on operating cost	22,220.00	20,900.00
Tax saving due to depreciation	16,500.00	13,933.33
operating cost- tax saving on depreciation and operating cost	62,280.00	60,166.67
Annuity PVIF at 10%	3.169865446	4.355260699
Present value	1,97,419.22	2,62,041.52
Total out flow	4,97,419.22	6,42,041.52
Yearly outflow	1,24,354.80	1,07,006.92
System B is more baneficial as it has yearly outflow of 60-watt incandescent light bulb costs 0.5 lasts for          1,000.00 hours Cost per hour 0.000500000 15-watt LED cost 3.65 lasts for        12,000.00 hours Cost per hour 0.000304167 Incandescent used for 500 hours Cost per hour 0.001000000 Average cost for us C58*0.5+C50*0.5 0.000750000 lesser value when compared with system A

cost per hour for LED light is less so we can replace

if cost per hour is for led light is less than 00.00075 than replace to led light