The technique for calculating a bid price can be extended to many other types of problems. Answer
In Previous Question Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 140,000 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 $1,800,000 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 $150,000. Your fixed production costs will be $265,000 per year, and your variable production costs should be $8.50 per carton. You also need an initial investment in net working capital of $130,000. If your tax rate is 35 percent and you require a 14 percent return on your investment, what bid price should you submit?
a. In the previous problem, assume that the price per carton is $16 and find the project NPV. What does your answer tell you about your bid price? What do you know about the number of cartons you can sell and still break even? How about your level of costs?
b. Solve the previous problem again with the price still at $16—but find the quantity of cartons per year that you can supply and still break even.
c. Repeat (b) with a price of $16 and a quantity of 140,000 cartons per year, and find the highest level of fixed costs you could afford and still break even.
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