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 136,000 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 $965,000 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 $118,000. Your fixed production costs will be $540,000 per year, and your variable production costs should be $18.45 per carton. You also need an initial investment in net working capital of $112,000. Assume your tax rate is 21 percent and you require a return of 11 percent on your investment. a. Assuming that the price per carton is $28.20, what is the NPV of this project? b. Assuming that the price per carton is $28.20, find the quantity of cartons per year you can supply and still break even. c. Assuming that the price per carton is $28.20, find the highest level of fixed costs you could afford each year and still break even. (Only round your answer to 2 decimal places, do not round intermediate calculations) a. NPV= b. Break-even number of cartons= c. Break-even fixed costs=

Answer 1

Solution : -

Given in Question
Cost of equipment = $9,65,000
Life of a project = 5 years
Salvage value = $1,18,000
Fixed production cost per year =$5,40,000
Variable cost per carton = $18.45
Working capital = $1,12,000
a. NPV of Project
(A)	(B)	( C )	( D ) = B* C
Year	Cash Flow	PV Factor @11%	Present value
0	(9,65,000 + 1,12,000) = -10,77,000	1.000	-10,77,000
1	6,56,514	0.901	591454.054
2	6,56,514	0.812	532841.490
3	6,56,514	0.731	480037.379
4	6,56,514	0.659	432466.107
5	6,56,514+1,12,000 = 7,68,514	0.593	455728.802
		Net present value	14,15,527.83
Calculation of Operating cash flow for a year
	Amount (in $)
Revenue(136,000 cartons * $28.20 )	38,35,200
Less: Variable cost (136,000 cartons * $18.45 per carton)	25,09,200
Contribution	13,26,000
Less: Fixed cost	5,40,000
Less: Depreciation	1,69,400
Net profit before tax	6,16,600
Less : Tax @21%	1,29,486
Net profit after tax	4,87,114
Add : Depreciation	1,69,400
Net cash Flow	6,56,514
Working note: - Calculation of depreciation
Cost of Equipment =$9,65,000
Salvage value = $1,18,000
Life of a project = 5 years
Straight line method = (Cost of Assets - Salvage value)/ Life of a asset
SLM = ($9,65,000 - $1,18,000)/5
SLM = 1,69,400
b. Break even number of cartons
Break even quantity = Fixed cost / Contribution per unit
Fixed cost = $5,40,000
Contribution per unit = Contribution / sale quantity of cartons
Contribution per unit = $13,26,000/ 136,000
9.75
BEQ = $5,40,000/ $9.75
Break even cartons quantity= 55384.61
c. Break even fixed costs
	Amount ( in $ )
Revenue(136,000 cartons * $28.20 )	38,35,200
Less: Variable cost (136,000 cartons * $18.45 per carton)	25,09,200
Contribution	13,26,000
Less: Fixed cost	13,26,000
Profit	-
Highest Level of Fixed cost of $ 13,26,000 can afford each year.