Question

Last month your company posted $100,000 with Contracts-R-Us to get approved to bid on contracts via their website. Trump Enterprises is looking for a supplier of red baseball caps, and your boss wants you to bid on the contract. The company requires 112,000 baseball caps per year over the next five years. You estimate that the necessary equipment will cost $790,000, and the equipment will be depreciated straight-line to zero over the project’s life. You believe this equipment can be sold for $62,000 at the end of the project. You further estimate the fixed costs to be $317,000 per year, and the variable production costs to be $9.50 per hat. You'll need an initial investment in net working capital of $67,000, but this will be recovered at the end of the project. Your tax rate is 35 percent and you require a return of 12 percent on your investment. What is the lowest bid price (per unit) you should submit (i.e. price where NPV=0)?

Part A: Start by calculating the operating cash flow that, when received as an annuity for 5 years, would set the NPV = 0.  (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

OCF*	$

Part B: Now calculate the bid price.  (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Bid price	$

Answer 1

Part A:

Before moving to calculation let us collect available information:

Contract	Requirement	Years	Year * Number of Unit
Customer Requirement	112000	5	560000

Based on the above information and 12% Expected rate of return, We will calculate Unit price (Need to consider tax percnatge while calculating Profit Margin of 12%)

	Y0	Y1	Y2	Y3	Y4	Y5
Initial Investment	$      790,000.00
Fixed Cost		$      317,000.00	$                     317,000.00	$      317,000.00	$      317,000.00	$      317,000.00
Variable Cost		$ 1,064,000.00	$                  1,064,000.00	$ 1,064,000.00	$ 1,064,000.00	$ 1,064,000.00
Working Capital	$        67,000.00
Scrap Value	$        62,000.00
Total Cost	$ 7,762,000.00
Less Scrap	$        38,017.60
Less WC	$        35,180.47
Cost Incurred	$ 7,688,801.94
Cost Per Unit	$                13.73
Margin Required	12%
Tax Percentage	35%
Adjusted Margin % Required	16.200%
Cost + Margin (Bid Price)	$                15.95

Once we identify the selling rate let us find Cash flow with NPV

		Y1	Y1	Y1	Y1	Y1
Cash Flows ($ 15.95 *112000)		$ 1,786,877.57	$                  1,786,877.57	$ 1,786,877.57	$ 1,786,877.57	$ 1,786,877.57
FC		$      317,000.00	$                     317,000.00	$      317,000.00	$      317,000.00	$      317,000.00
VC		$ 1,064,000.00	$                  1,064,000.00	$ 1,064,000.00	$ 1,064,000.00	$ 1,064,000.00
Cash Flows Before Tax		$      405,877.57	$                     405,877.57	$      405,877.57	$      405,877.57	$      405,877.57
35% Tax		$      142,057.15	$                     142,057.15	$      142,057.15	$      142,057.15	$      142,057.15
Cash at year end		$      263,820.42	$                     263,820.42	$      263,820.42	$      263,820.42	$      263,820.42
Considering Time value of Money		$      235,553.95	$                     210,316.02	$      187,782.16	$      167,662.65	$      149,698.79
Less Scrap						$        35,180.47
Less WC						$        38,017.60
NPV (Operating Cash Flow)	$    1,024,211.64

Kindly let us know if further queries.

Thanks.