Question

Guthrie Enterprises needs someone to supply it with 147,000 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 $1,870,000 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 $157,000. Your fixed production costs will be $272,000 per year, and your variable production costs should be $9.20 per carton. You also need an initial investment in net working capital of $137,000. If your tax rate is 38 percent and you require a return of 13 percent on your investment, what bid price per carton should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Let the bid price be $ x per carton.

Now we have to find the NPV of the equipment . The minimum bid price will be price which makes NPV=0.

NPV = Present value of Cash Inflows - Present value of Cash Outflows

PVIFA = (1 - (1 + r)^-n) / r = ( 1 - 1.13^-5)/ 0.13 = 3.517231

Depreciation = (Historical cost - Salvage value ) / no of years

= (1870000 - 157000) / 5 = 342600

First Lets calculate the Present value of cash outflows

A .

Present value of Cash Outflows = Presnt value of equipment + Present value of working capital involved

= 1870000 + 137000 = 2007000

B

Present value of Operating in Cashflows = [{(Sales - Variable Cost )*no of cartons per year - Fixed costs - Depreciation )} * (1 - tax rate) + depreciation ] * PVIFA ( rate of interest , no of years)

=[{( x - 9.20 )*147000 - 272000 - 342600}*(1-0.38) + 342600] * PVIFA ( 13 %, 5)

=[(147000x -1352400 - 272000 - 342600)*0.62 + 342600] * 3.517231

= (91140x - 1219540+ 342600)*3.517231

= 320560.20x - 3084401.7825

C.

Present value of Terminal Cashinflows = Present value of salvage value + present value of working capital

= 157000 / 1.13^5 + 137000 /1.13^5

= 157000/ 1.8424 + 137000/1.8424

= 85214.9370 + 74359.5310

= 159574.468

Now as per the euation , NPV = O

B+C-A = 0

320560.20x - 3084401.7825 + 159574.468 - 2007000 = 0

320560.20x = 4931826.3145

x = 15.3850

= 15.39

the bid price per carton should be = $15.39