Question

JuJu Enterprises needs someone to supply it with 100,000 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 $840,000 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 sold for $55,000. Your fixed production costs will be $435,000 per year, and your variable production costs should be $15.10 per carton. You also need an initial investment in net working capital of $75,000. If your tax rate is 35 percent and you require a return of 14 percent on your investment, what bid price should you submit?

Answer 1

After tax salvage value = (1 - 0.35) * 55000 = 35750

Year	0	1	2	3	4	5
OCF		?	?	?	?	?
NCS	-840000					35750
Ch NWC	-75000					75000
CFFA	-915000	?	?	?	?	110750

To find the needed OCF to break even, use your calculator with n=5, PV=-915,000,FV=110,750, r=14%, and solve for PMT. You should get OCF = PMT = 249769.79

Now, using

OCF = (Sales - Costs) x (1 - T) + Depr x T

Depr = 840,000 / 5 = 168,000

Costs = FC + VC x Q

= 435,000 + 15.10 * 100,000 = 1,945,000

Sales = ( OCF - Depr x T + Costs x (1 - T) ) / (1 - T)

= ( 249769.79 - 168000*.35 + 1945000*(1-0.35)/ (1-0.35)

= 1455219.79

or

1455220 / 100000 = 14.55 per Box