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 126,000 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 $930,000 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 $76,000. Your fixed production costs will be $331,000 per year, and your variable production costs should be $10.90 per carton. You also need an initial investment in net working capital of $81,000. Assume your tax rate is 35 percent and you require a 12 percent return on your investment.

a. Assuming that the price per carton is $17.60, 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 $17.60, 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 $17.60, 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

Romo	0	1	2	3	4	5
Investment	-$930,000
NWC	-$81,000					$81,000
Salvage						$76,000
Sales		$2,217,600	$2,217,600	$2,217,600	$2,217,600	$2,217,600
VC		-$1,373,400	-$1,373,400	-$1,373,400	-$1,373,400	-$1,373,400
FC		-$331,000	-$331,000	-$331,000	-$331,000	-$331,000
Depreciation		-$186,000	-$186,000	-$186,000	-$186,000	-$186,000
EBT		$327,200	$327,200	$327,200	$327,200	$327,200
Tax (35%)		-$114,520	-$114,520	-$114,520	-$114,520	-$114,520
Net Profits		$212,680	$212,680	$212,680	$212,680	$212,680
Cash Flows	-$1,011,000	$398,680	$398,680	$398,680	$398,680	$529,080
NPV	$500,144.64

Sales = 126,000 x 17.6 = 2,217,600

VC = 126,000 x 10.9 = 1,373,400

Depreciation = 930,000 / 5 = 186,000

Cash Flows = Net Income + Depreciation + Investment + NWC + Salvage x (1 - tax rate)

NPV can be calculated using NPV function on a calculator or excel with 12% rate.

NPV = $500,144.64

b) Break even quantity can be calculated using trial and error by changing the no. of cartons at which NPV = 0

Break-even cartons = 94,141

c) Similarly,

Break-even fixed cost = 544,453.83