Question

The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price; that is, set the project NPV to zero and solve for the variable in question. Guthrie Enterprises needs someone to supply it with 153,000 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 $1,930,000 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 $163,000. Your fixed production costs will be $278,000 per year, and your variable production costs should be $10.70 per carton. You also need an initial investment in net working capital of $143,000. The tax rate is 23 percent and you require a return of 10 percent on your investment. Assume that the price per carton is $17.30.

a.	Calculate the project NPV.
b.	What is the minimum number of cartons per year that can be supplied and still break even?
c.	What is the highest fixed costs that could be incurred and still break even?

Answer 1

NPV = -1,930,000 – 143,000 + 645,350*PVAF(10%, 5 years) + 265,250*PVF(10%, 5 years)

=-2,073,000 + 645,350*3.7908 + 265,250*0.6209

= $ 538,086.51

b.Let minimum number be x

To break even, NPV = 0

0 = -2,073,000+{(6.6x – 664,000)0.75 + 386,000}3.7908 + 265,250*0.6209

0 = -2,073,000 + 18.7645x – 424,570 + 164,693.73

X = 124,323.92 or 124,324 cartons

c. Let highest fixed cost be x

0 =-2,073,000+{(1,009,800-x-386,000)0.75 + 386,000}3.7908 + 265,250*0.6209

0 = -2,073,000 + 2,870,962 – 2.8431x + 164,693.73

X = $ 338,593.69