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 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 $915,000 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 $88,000. Your fixed production costs will be $490,000 per year, and your variable production costs should be $17.45 per carton. You also need an initial investment in net working capital of $92,000. Assume your tax rate is 21 percent and you require a return of 10 percent on your investment a. Assuming that the price per carton is $26.20, 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 $26.20, 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 $26.20, 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. a. NPV b. Break-even number of cartons c. Break-even fixed costs

Answer 1

Sales Quantity	126000
Selling Price oer unit	26.2
Less: Variable Cost per unit	17.45
Contribution per unit	8.75
Contribution [Sales Quantity*Contribution per unit]	1102500
Less:Fixed Costs	490000
EBIT	612500
Less: Depreciation [(915000-88000)/5]	165400
Profit Before Tax	447100
Less: Tax@21% [Profit Before Tax*0.21]	93891
Profit After Tax	353209
Add: Depreciation	165400
Cash Flow	518609
Initial Outlay = Cost of Equipment + Working Capital	915000 + 92000	1007000
Last year additional cash flow = Salvage Value + Working Capital	88000 + 92000	180000
Year	Discounting Factor [1/(1.1^year)]	Cash Flow	PV of Cash Flows (cash flow*discounting factor)
0	1	-1007000	-1007000
1	0.909090909	518609	471462.7273
2	0.826446281	518609	428602.4793
3	0.751314801	518609	389638.6176
4	0.683013455	518609	354216.9251
5	0.620921323	518609	322015.3864
5	0.620921323	180000	111765.8382
		NPV = Sum of PVs	1070701.974
a) NPV =	1070701.97
b) Breakeven = Fixed Cost/Contribution per unit =	490000/8.75	56000 cartons
c) Maximum Fixed Cost = Contribution =	1102500