Question

The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price; that is, set the project NPV to zero and solve for the variable in question. Guthrie Enterprises needs someone to supply it with 150,000 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 $1,900,000 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 $160,000. Your fixed production costs will be $275,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $140,000. The tax rate is 25 percent and you require a return of 12 percent on your investment. Assume that the price per carton is $17.00. a. Calculate the project NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What is the minimum number of cartons per year that can be supplied and still break even? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) c. What is the highest fixed costs that could be incurred and still break even? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV Quantity of cartons Fixed costs

Answer 1

Initial Investment=1900000+140000=$2040000

Depreciation cost per year=1,900,000/5=$380000

Fixed Cost=$275000

Gross Profit per year=(17-10.4)*150000-275000=$715000

Taxable profit= Gross Profit- Depreciation=715000-380000=$335000

Tax=335000*25%=$83750

Cash flow=715000-83750=$631250

5th year cash flow including salvage value=631250+160000=$791250

Year	Cash Flow	Present Value (Cash Flow/1.12^year)
-	(2,040,000)	(2,040,000)
1	631,250	563,616
2	631,250	503,229
3	631,250	449,311
4	631,250	401,171
5	791,250	448,976
	NPV (Total Present Value)	326,303

a. Hence, NPV of the project is $326303

b. Say, x is the minimum number of cartons

Now, Gross Profit=x*(17-10.4)-275000

Profit After depreciation=x*(17-10.4)-275000-380000=0

now, 6.6x=655000

or, x=99242.42 or 99242 (Approx)

c. say, the highest fixed cost that can be undertaken is y

Then,  (17-10.4)*150000-y-380000=0

or, y=(17-10.4)*150000-380000=610000

Hence, highest fixed cost that be incurred is $610000