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 141,000 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 $990,000 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 $133,000. Your fixed production costs will be $565,000 per year, and your variable production costs should be $18.95 per carton. You also need an initial investment in net working capital of $122,000. Assume your tax rate is 21 percent and you require a return of 10 percent on your investment.

  

a.	Assuming that the price per carton is $29.20, 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 $29.20, 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 $29.20, 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 of the project is +$1,725,789

Working Note:

Step1:
Cost of Equipment	$      990,000.00
Add: Working Capital	$      122,000.00
Total Initial Outflow	$ 1,112,000.00
Step2:		Year 1	Year 2	Year 3	Year 4	Year 5
Sales Qty		$       141,000.00	$      141,000.00	$       141,000.00	$      141,000.00	$      141,000.00
Sales Price		$                  29.20	$                29.20	$                  29.20	$                29.20	$                29.20
Sales Value		$    4,117,200.00	$ 4,117,200.00	$    4,117,200.00	$ 4,117,200.00	$ 4,117,200.00
Less: Variable Cost(Qty*18.95)		$    2,671,950.00	$ 2,671,950.00	$    2,671,950.00	$ 2,671,950.00	$ 2,671,950.00
Contribution		$    1,445,250.00	$ 1,445,250.00	$    1,445,250.00	$ 1,445,250.00	$ 1,445,250.00
Less: Fixed Cost		$       565,000.00	$      565,000.00	$       565,000.00	$      565,000.00	$      565,000.00
Less: Depreciation		$       171,400.00	$      171,400.00	$       171,400.00	$      171,400.00	$      171,400.00
EBIT		$       708,850.00	$      708,850.00	$       708,850.00	$      708,850.00	$      708,850.00
Less: Tax @ 21%		$       148,858.50	$      148,858.50	$       148,858.50	$      148,858.50	$      148,858.50
Profit After Tax		$       559,991.50	$      559,991.50	$       559,991.50	$      559,991.50	$      559,991.50
Free Cash flow = PAT + Depreciation		$       731,391.50	$      731,391.50	$       731,391.50	$      731,391.50	$      731,391.50
Salvage Value after Tax						$      105,070.00
Step3: consolidation
	Year	CFAT	PVF @ 10% =1/(1+r)^n	DCFAT
	0	$ (1,112,000.00)	1	$       (1,112,000)
	1	$       731,391.50	$                0.909	$       664,901.36
	2	$       731,391.50	$                0.826	$       604,455.79
	3	$       731,391.50	$                0.751	$       549,505.26
	4	$       731,391.50	$                0.683	$       499,550.24
	5	$       836,461.50	$                0.621	$       519,376.78
		NPV		$    1,725,789.42
Net Present Value = Present Value of Inflow - Present Value of Outflow
Present Value of Inflow=	$        2,837,789
Present Value of Outlfow =	$        1,112,000
NPV=	$        1,725,789

Depreciation=	171,400
Salvage Value	$      133,000.00
Book Value at the end of 5th year=	0
Profit on Sales	$      133,000.00
Tax @21%	$        27,930.00
Salvage Value after Tax	$      105,070.00

b).Quantity of cartoon = 55,122

Working Note:

Sales Value		$    4,117,200.00	$ 4,117,200.00	$    4,117,200.00	$ 4,117,200.00	$ 4,117,200.00
Less: Variable Cost(Qty*18.95)		$    2,671,950.00	$ 2,671,950.00	$    2,671,950.00	$ 2,671,950.00	$ 2,671,950.00
Contribution		$    1,445,250.00	$ 1,445,250.00	$    1,445,250.00	$ 1,445,250.00	$ 1,445,250.00
PV Ratio=		35%	35%	35%	35%	35%
Less: Fixed Cost		$       565,000.00	$      565,000.00	$       565,000.00	$      565,000.00	$      565,000.00
Break even = Fixed Cost / PV ratio		$    1,609,560.98	$ 1,609,560.98	$    1,609,560.98	$ 1,609,560.98	$ 1,609,560.98
Qty of cartoon per year for break even		55,121.95	55,121.95	55,121.95	55,121.95	55,121.95

c).

Break even under highest level of fixed cost.

Quantity of cartoon = 71,844

Sales Value

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