Question

Guthrie Enterprises needs someone to supply it with 155,000 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 $1,950,000 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 $165,000. Your fixed production costs will be $280,000 per year, and your variable production costs should be $10.00 per carton. You also need an initial investment in net working capital of $145,000. If your tax rate is 40 percent and you require a return of 14 percent on your investment, what bid price per carton should you submit?

Answer 1

Formula	Year (n)	0	1	2	3	4	5
	Initial investment (I)	-19,50,000
	Units of cartons (U)		1,55,000	1,55,000	1,55,000	1,55,000	1,55,000
	Price/carton (p)		16.29	16.29	16.29	16.29	16.29
	Variable cost/carton (vc)		10.00	10.00	10.00	10.00	10.00
(U*p)	Revenue ('R)		25,25,543	25,25,543	25,25,543	25,25,543	25,25,543
(U*vc)	Total Variable Cost (VC)		15,50,000	15,50,000	15,50,000	15,50,000	15,50,000
	Fixed Cost (FC)		2,80,000	2,80,000	2,80,000	2,80,000	2,80,000
(I/5)	Depreciation (D)		3,90,000	3,90,000	3,90,000	3,90,000	3,90,000
(R-VC-FC-D)	EBIT		3,05,543	3,05,543	3,05,543	3,05,543	3,05,543
40%*EBIT	Tax @ 40%		1,22,217	1,22,217	1,22,217	1,22,217	1,22,217
(EBIT-Tax)	Net income (NI)		1,83,326	1,83,326	1,83,326	1,83,326	1,83,326
	Add: Depreciation (D)		3,90,000	3,90,000	3,90,000	3,90,000	3,90,000
(NI+D)	OCF		5,73,326	5,73,326	5,73,326	5,73,326	5,73,326
(WC is returned at the end of the project)	WC investment (WC)	-1,45,000					1,45,000
salvage*(1-tax)	After-tax salvage (S)						99,000
(I+OCF+WC+S)	Total cash flows (CF)	-20,95,000	5,73,326	5,73,326	5,73,326	5,73,326	8,17,326
1/(1+d)^n	Discount factor @14%	1.000	0.877	0.769	0.675	0.592	0.519
CF*Discount factor	PV of CF	-20,95,000	5,02,917	4,41,156	3,86,979	3,39,455	4,24,493
	NPV	-0.00

Solved using excel Solver. The break even price per carton is $16.29. So, this bid price should do. Ideally it should be slightly higher than this.