Question

Dahlia Enterprises needs someone to supply it with 110,000 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 $770,000 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 $60,000. Your fixed production costs will be $315,000 per year, and your variable production costs should be $9.30 per carton. You also need an initial investment in net working capital of $65,000. If your tax rate is 34 percent and your required return is 10 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Bid price $----??

Answer 1

after tax salvage value = 60000*(1-tax rate) = 60000*(1-.34) = 39600

NPV =0 = Initial investment+ present value of operating cash flow at 10% for for 5 years period + present value of after tax salvage value + recovery of working capital at 10%, year 5

0 = -770000-65000+OCf*PVAF at 10% for 5 years+(after tax salvage value+recovery of working capital)*PVF at 10% at 5 year

0 = -770000-65000+OCF *3.7907+(65000+39600)*.6209

0 = -835000+3.7907 OCF + 64948.37039

OCF = 770051.6296/3.7907 = 203142.33

PVAF at 10% for % years = 1-(1+r)^-n / r = 1-(1.1)^-5 / 10% = .3790/10% = 3.7907

PVF at 10% at 5 year =1/(1+r)^n =1/(1.1)^5 =.6209

Bid Price Using Tax shied apporach

OCF = $203,142.33 = [(P − v)Q − FC](1 − T) + Tax shield on Depreciation

203142.33 =[(P-9.3)*110000-315000]*(1-.34)+ (770000/5)*34%

203142.33 = [110000 P-1023000-350000]*(.66) +52360

203142.33 = [110000P-1373000)*.66 +52360

203142.33 = 72600P -906180+52360

203142.33 = 72600P-853820

1056962.33 = 72600 P

p = 1056962.33/72600 = 14.56

Bid Price per Unit = 14.56