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.

Romo Enterprises needs someone to supply it with 115,000 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 $820,000 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 $65,000. Your fixed production costs will be $320,000 per year, and your variable production costs should be $9.80 per carton. You also need an initial investment in net working capital of $70,000. Assume your tax rate is 35 percent and you require a 12 percent return on your investment.

  

a.	Assuming that the price per carton is $16.50, 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 $16.50, 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 $16.50, 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

$

Answer 1

a) Statement showing NPV

Particulars	0	1	2	3	4	5	NPV
Cost of machine	-820000
WC required	-70000
SPPU		16.5	16.5	16.5	16.5	16.5
VCPU		9.8	9.8	9.8	9.8	9.8
CPU		6.7	6.7	6.7	6.7	6.7
No of units		115000	115000	115000	115000	115000
Total contribution		770500	770500	770500	770500	770500
Fixed cost		320000	320000	320000	320000	320000
Depreciation		164000	164000	164000	164000	164000
PBT		286500	286500	286500	286500	286500
Tax @ 35%		100275	100275	100275	100275	100275
PAT		186225	186225	186225	186225	186225
Add: depreciation		164000	164000	164000	164000	164000
Cash flow		350225	350225	350225	350225	350225
Salvage value(65000-35%)						42250.00
WC release						70000
Total cash flow	-890000	350225	350225	350225	350225	462475
PVIF @ 12%	1	0.892857143	0.797193878	0.711780248	0.635518078	0.5674269
Present value	-890000	312701	279197	249283	222574	262421	436176

b) Break even point = Fixed cost/CPU

=Fixed cost+ depreciation/ CPU

=320000+164000/6.7

=484000/6.7

=72238.81 ie 72239 units

C) Highest level of fixed cost = units * CPU

=115000*6.7

= 770500