Question

The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price; that is, set the project NPV to zero and solve for the variable in question.

Guthrie Enterprises needs someone to supply it with 127,000 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 $940,000 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 $77,000. Your fixed production costs will be $332,000 per year, and your variable production costs should be $11.00 per carton. You also need an initial investment in net working capital of $82,000. Assume the tax rate is 30 percent and the required return on the investment is 11 percent.

a. Assuming that the price per carton is $17.70, what is the NPV of this project?

b. Assuming that the price per carton is $17.70, find the quantity of cartons per year you need to supply to break even.

c. Assuming that the price per carton is $17.70, find the highest level of fixed costs you could afford each year and still break even.

Answer 1

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