Question

Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 146,000 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 $1,860,000 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 $156,000. Your fixed production costs will be $271,000 per year, and your variable production costs should be $9.10 per carton. You also need an initial investment in net working capital of $136,000. The tax rate is 35 percent and you require a return of 12 percent on your investment. Assume that the price per carton is $16.60. Calculate the project NPV. What is the minimum number of cartons per year that can be supplied and still break even? What is the highest fixed costs that could be incurred and still break even?

Answer 1

NPV	538,767
Break even units	115,342
Highest fixed Cost	500,940
Details of calculations
	0	1	2	3	4	5	NPV
Cost of Equipment	-1,860,000						538,767
Initial Working Capital	-136,000
Salvage Value						156,000
Tax on Salvage Value						-54,600
Release of Working Capital						136,000
Capital (Outflow)/Inflow	-1,996,000	-	-	-	-	237,400
Units		146,000	146,000	146,000	146,000	146,000
Sales Price		2,423,600	2,423,600	2,423,600	2,423,600	2,423,600
Variable prod. Cost		-1,328,600	-1,328,600	-1,328,600	-1,328,600	-1,328,600
Contribution		1,095,000	1,095,000	1,095,000	1,095,000	1,095,000
Fixed Production Cost		-271,000	-271,000	-271,000	-271,000	-271,000
Depreciation		-372,000	-372,000	-372,000	-372,000	-372,000
Profit Before Tax		452,000	452,000	452,000	452,000	452,000
Tax at 35%		158,200	158,200	158,200	158,200	158,200
Profit After Tax		293,800	293,800	293,800	293,800	293,800
Add: Depn		372,000	372,000	372,000	372,000	372,000
Operating Cash Flow		665,800	665,800	665,800	665,800	665,800
Free Cash Flow	-1,996,000	665,800	665,800	665,800	665,800	903,200
Disc. Rate=1/(1+12%)^n	1.0000	0.8929	0.7972	0.7118	0.6355	0.5674
Dis. Free Cash Flow	-1,996,000	594,464	530,772	473,903	423,128	512,500
Break Even units
	PV of the contribution
	Contribution per unit after tax=(16.6-9.1)*(1-35%)				4.875
	Discount factor of annuity of 5 years at 12%				3.6048
	PV of the total contribution=4.875*3.6048				17.5734
	PV of the fixed cost
	Fixed cost				271000
	Tax saving due to fixed cost=136000*35%				94850
	Fixed Cost outflow				176150
	Discount factor of annuity of 5 years at 12%				3.6048
	PV of the total fixed cost=88400*3.6048				634,985.52
	Tax saving due to depreciation
	Depreciation				372,000
	Tax saving due to depreciation=372000*35%				130,200
	Discount factor of annuity of 5 years at 12%				3.6048
	PV of the total tax saving due to depn=130200*3.6048				469,344.96
	PV of the release of working capital & salvage value
	Total Inflow at the end of 5th year				237400
	Disc fact				0.5674
	PV of the inflow				134700.76
	So break even point would be =0=17.5734x-634985.52+469344.96+134700.76-1996000
		17.5734x=2026940
		x=115341.36
	Break even point would be 115,342 units
Highest Fixed cost at break even
	Maximum fixed cost to BEP point
	So break even point would be =0=17.5734*146000-x+469344.96+134700.76-1996000
		x=1173762	Pv of the fixed cost after tax
	fixed cost per year after tax=1173762/3.6048				325,610.85
	Total fixed cost =325610.85/(1-35%)				500,940