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 130,000 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 $935,000 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 $100,000. Your fixed production costs will be $510,000 per year, and your variable production costs should be $17.85 per carton. You also need an initial investment in net working capital of $100,000. Assume your tax rate is 25 percent and you require a return of 11 percent on your investment.

  

a.	Assuming that the price per carton is $27.00, 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 $27.00, 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 $27.00, 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.)

Answer 1

a). NPV = 1,125,158.69

Formula	Year (n)	0	1	2	3	4	5
	Initial investment (II)	935,000
	Number of cartons (u)		130,000	130,000	130,000	130,000	130,000
	Price per carton (p)		27	27	27	27	27
	Variable cost per carton (vc)		18	18	18	18	18
u*p	Revenue ('R)		3,510,000	3,510,000	3,510,000	3,510,000	3,510,000
u*vc	Variable Cost (VC)		2,320,500	2,320,500	2,320,500	2,320,500	2,320,500
	Fixed Cost (FC)		510,000	510,000	510,000	510,000	510,000
	Depreciation (D)		187,000	187,000	187,000	187,000	187,000
R-VC-FC-D	EBIT		492,500	492,500	492,500	492,500	492,500
25%*EBIT	Tax @ 25%		123,125	123,125	123,125	123,125	123,125
EBIT - Tax	Net income (NI)		369,375	369,375	369,375	369,375	369,375
	Add: depreciation (D)		187,000	187,000	187,000	187,000	187,000
NI + D	Operating Cash Flow (OCF)		556,375	556,375	556,375	556,375	556,375
	NWC	(100,000)					100,000
	Salvage price (s)						100,000
s*(1-Tax rate)	After-tax salvage price (SV)						75,000
OCF+NWC+SV-II	Free Cash Flow (FCF)	(1,035,000)	556,375	556,375	556,375	556,375	731,375
1/(1+d)^n	Discount factor @ 11%	1.000	0.901	0.812	0.731	0.659	0.593
FCF*Discount factor	PV of FCF	(1,035,000.00)	501,238.74	451,566.43	406,816.60	366,501.45	434,035.47
Sum of all PVs	NPV	1,125,158.69

b). Using the NPV table above with Solver, to set NPV to zero by changing the number of cartons per year, the break-even number of cartons are 85,638.

c). Again, using Solver and setting NPV to zero by changing fixed costs, the break-even fixed cost is 915,912.71