Question

Guthrie Enterprises needs someone to supply it with 145,000 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 $2,000,000 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 $155,000. Your fixed production costs will be $640,000 per year, and your variable production costs should be $8.99 per carton. You also need an initial investment in net working capital of $310,000. If your tax rate is 24 percent and you require a 13 percent return on your investment, what bid price per carton should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Bid price

Answer 1

The bid price should be the price at which NPV breaks even. Using Solver, we get a price per carton of 17.89.

Formula	Year (n)	0	1	2	3	4	5
	Initial investment (II)	2,000,000
	Number of cartons (u)		145,000	145,000	145,000	145,000	145,000
	Price per carton (p)		17.89	17.89	17.89	17.89	17.89
	Variable cost per carton (vc)		8.99	8.99	8.99	8.99	8.99
u*p	Revenue ('R)		2,594,538	2,594,538	2,594,538	2,594,538	2,594,538
u*vc	Variable Cost (VC)		1,303,550	1,303,550	1,303,550	1,303,550	1,303,550
	Fixed Cost (FC)		640,000	640,000	640,000	640,000	640,000
	Depreciation (D)		400,000	400,000	400,000	400,000	400,000
R-VC-FC-D	EBIT		250,988	250,988	250,988	250,988	250,988
25%*EBIT	Tax @ 24%		60,237	60,237	60,237	60,237	60,237
EBIT - Tax	Net income (NI)		190,751	190,751	190,751	190,751	190,751
	Add: depreciation (D)		400,000	400,000	400,000	400,000	400,000
NI + D	Operating Cash Flow (OCF)		590,751	590,751	590,751	590,751	590,751
	NWC	(310,000)					310,000
	Salvage price (s)						155,000
s*(1-Tax rate)	After-tax salvage price (SV)						117,800
OCF+NWC+SV-II	Free Cash Flow (FCF)	(2,310,000)	590,751	590,751	590,751	590,751	1,018,551
1/(1+d)^n	Discount factor @ 13%	1.000	0.885	0.783	0.693	0.613	0.543
FCF*Discount factor	PV of FCF	(2,310,000.00)	522,788.35	462,644.56	409,419.96	362,318.55	552,828.59
Sum of all PVs	NPV	(0.00)