Question

Bebe Enterprise needs someone to supply it with 100,000 pcs of generators per year to support its manufacturing needs over the next 5 years, and you've decided to bid on the contract. It will cost you $600,000 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 5 years, this equipment can be salvaged for $50,000 (before tax). Your fixed production costs will be $500,000 per year, and your variable production costs should be $30 per pcs. You also need an initial investment in net working capital of $100,000. If your tax rate is 30% and you require a 12% return on your investment, what is our proper bid price per pcs?

Answer 1

Operating cash flow (OCF) each year = income after tax + depreciation

profit on sale of equipment at end of year 5 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of equipment   

First, we assume a bid price of $35.00 and calculate the NPV

NPV is -$493,625

The proper bid price is the bid price where NPV is at least zero. If NPV is negative, the bid price is too low.

The proper bid price is calculated using GoalSeek in Excel. We need to find the bid price such that NPV is at least zero

The proper bid price is $36.96