Question

Guthrie Enterprises needs someone to supply it with 148,000 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 $1,880,000 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 $158,000. Your fixed production costs will be $273,000 per year, and your variable production costs should be $9.30 per carton. You also need an initial investment in net working capital of $138,000. If your tax rate is 40 percent and you require a return of 14 percent on your investment, what bid price per carton should you submit?

Answer 1

Answer: Bid price per carton : $ 15.67

Initial Investment = - $ ( 1,880,000 + 138,000) = - $ 2,018,000

Terminal Cash Flows = $ ( 138,000 + $ 158,000 x 0.60) = $ 232,800.

Annual depreciation = $ 1,880,000 / 5 = $ 376,000

Let the price per carton be P.

Set the NPV at 0.

So [ {148,000 x ( P - 9.30 ) - 273,000 ] x 0.60 + 376,000 x 0.40) } ] x [ 1 - ( 1 / 1.14 ) ⁵ } / 0.05 ] + $ 232,800 x ( 1 / 1.14 ) ⁵ - $ 2,018,000 = [ { 148,000 P - 1,376,400 - 273,000 } x 0.60 + 150,400 ] x 3.433081 + $ 232,800 x 0.51937 = 2,018,000

or (88,800 P - 839,240) x 3.433081 + 120,909.34 = 2,018,000

or 304,857.59 P - 2,881,178.90 + 120,909.34 = 2,018,000

or P = $ 15.67