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 111,000 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 $780,000 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 $61,000. Your fixed production costs will be $316,000 per year, and your variable production costs should be $9.40 per carton. You also need an initial investment in net working capital of $66,000. Assume your tax rate is 30 percent and you require a 11 percent return on your investment. a. Assuming that the price per carton is $16.10, 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 $16.10, 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 $16.10, 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

NPV of the project works out to $267310.94

Initial investment is $846,000 which is Capex of $780,000+ Working Capital of $66,000

Operating cash flow (OCF) per annum works out to $299,390

The solution has been worked on a excel spreadsheet. Please find the table for detailed analysis.

Year	0	1	2	3	4	5
Investment	($846,000)					$61,000
Revenue		$1,787,100.00	$1,787,100.00	$1,787,100.00	$1,787,100.00	$1,787,100.00
Fixed Cost		$316,000	$316,000	$316,000	$316,000	$316,000
Variable Cost		$1,043,400.00	$1,043,400.00	$1,043,400.00	$1,043,400.00	$1,043,400.00
Depreciation		$156,000	$156,000	$156,000	$156,000	$156,000
Tax		128310	128310	128310	128310	128310
Annual Cash Flows		$299,390.00	$299,390.00	$299,390.00	$299,390.00	$299,390.00
Net Cash Flows	($846,000)	$299,390.00	$299,390.00	$299,390.00	$299,390.00	$360,390.00
NPV	$267,310.94

b. If we make NPV = 0 by reducing the quantity we reach the break even point. This works out to 93883 cartons. Alternately if we ignore the ROI and go by the formula of break even as Fixed Cost =Quantity x (Sale Price - Variable Cost) the break even works out to 47,164 cartons

c. If we make NPV = 0 by increasing the fixed costs but keeping the quantity constant the break even point works to $430689. Alternately if we ignore ROI and NPV and take a simple formula as in "b", the maximum fixed cost affordable is 111000x (16.1-9.4) = $743,700

b & c indicate that taxation and time value of money has a significant impact on the break even point.