Question

Mongo Inc. needs someone to supply it with 200,000 cartons of machine screws 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 $1,200,000 after-tax 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 $75,000 before-tax. Your fixed production costs will be $350,000 before-tax per year, and your variable production costs should be $12.00 before-tax per carton. You also need an initial increase in account receivables of $100,000 and a decrease in account payable of $150,000, all of which will be recovered when the project ends. Your tax rate is 20 percent and you require a 10 percent return on your investment. What bid price per carton should you submit?

Answer 1

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

Investment in working capital = increase in receivables + decrease in payables

Investment in working capital = $100,000 + $150,000 = $250,000

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

book value = original cost - accumulated depreciation

The book value is zero as the equipment is fully depreciated

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

First, we assume the bid price to be $15, and compute the NPV.

NPV is calculated using NPV function in Excel

NPV is -$319,399

Minimum bid price is where the NPV equals zero.

Minimum bid price is calculated using GoalSeek in Excel

Minimum bid price is $15.52