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.

Martin Enterprises needs someone to supply it with 136,000 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 $965,000 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 $118,000. Your fixed production costs will be $540,000 per year, and your variable production costs should be $18.45 per carton. You also need an initial investment in net working capital of $112,000. Assume your tax rate is 21 percent and you require a return of 11 percent on your investment.

  

a.	Assuming that the price per carton is $28.20, what is the NPV of this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Assuming that the price per carton is $28.20, find the quantity of cartons per year you can supply and still break even. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
c.	Assuming that the price per carton is $28.20, 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.)

  

Answer 1

a]

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

In year 5, the working capital investment is recovered.

profit on sale of equipment at end of year 4 = 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   

NPV is are calculated using NPV function in Excel

NPV is $1,489,513.08

b]

To breakeven, the NPV should be zero.

The quantity of cartons per year at which NPV is zero is calculated using GoalSeek in Excel.

The quantity of cartons per year at which NPV is zero is 83,677 cartons

c]

To breakeven, the NPV should be zero.

The fixed costs per year at which NPV is zero is calculated using GoalSeek in Excel.

The fixed costs per year at which NPV is zero is $1,050,149.39

The fixed costs per year at which NPV is zero is $1,050,149.39