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.

Romo Enterprises needs someone to supply it with 130,000 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 $970,000 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 $80,000. Your fixed production costs will be $335,000 per year, and your variable production costs should be $11.30 per carton. You also need an initial investment in net working capital of $85,000. Assume your tax rate is 30 percent and you require a 11 percent return on your investment.

  

a.	Assuming that the price per carton is $18.00, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

  

b.	Assuming that the price per carton is $18.00, find the quantity of cartons per year you need to supply to break even. (Do not round intermediate calculations and round your answer to nearest whole number.)

  

Quantity of cartons

  

c.	Assuming that the price per carton is $18.00, find the highest level of fixed costs you could afford each year and still break even. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Fixed costs

$

Answer 1

Total value of machine	970000
Period	5 Years
Depreciation per year	194000
Tax Saving on Dep	58200

Cash inflow Per Year	130000	$18	2340000
Cash out flow
Variable cost	130000	$11.30	1469000
Fixed Cost			335000
Profit			536000
Tax	30%		160800
Profit after tax			375200
Tax Saving on Depriciation			58200
Net cash Inflow Per Year			433400

	Disc Factor at 11%
Year 1	0.90
Year 2	0.81
Year 3	0.73
Year 4	0.66
Year 5	0.59
Total	3.70

It is assume that depreciation is included in fixed production cost

Present value of Cash inflow	4334008*(sum of disc factor of five years)
	433400*3.69
Present value of Cash inflow	1603580
present value of Salvage value	80000*(dics factor at 5th year)
present value of Salvage value	80000* 0.60= 47200

Calculation of NPV of project= present value of Cash inflow + present value of Salvage value - Working capital Iinvestment in

initial year

=1603580 + 47472 - 85000

NPV of project = 1565780

b) Calculation of Break Even Quantity

Break Even Quantity = Fixed Cost /(Sale price - Variable cost)

335000/(18-11.30)

=335000/6.7

Break even quantity = 50000 cartons

C ) Highest level of Fixed cost = No of quantity *(Sale-Variable cost)

= 130000*6.7

Highest level of Fixed cost = 871000

$ 871000 is the highest level of fixed cost can be afford each year and still at break even