Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2628540 • Letter: A
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 154,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you 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 154,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and youExplanation / Answer
Another utilization of cash ow analysis is setting the bid price on a project. To calculate
the bid price, we set the project NPV equal to zero and nd the lowest acceptable bid price. Thus the
bid price represents a nancial break-even level for the project. Handsome Enterprise needs someone
to supply it with 130,000 cartons of machine screws per year to support its manufacturing needs over
the next ve years, and youve decided to bid on the contract. It will cost you $830,000 to install the
equipment necessary to start production; you will depreciate this cost straight-line to zero over the
projects life. You estimate that in ve years this equipment can be salvaged for $60,000. Your costs
of goods sold have two components: xed costs $210,000 per year and variable costs $8.5 per carton.
You also need an initial investment in net working capital of $75,000 (one-time only). You have asked
your project assistant Siri to produce a ball-park gure of the bid price. She has decided that $12.34
per carton is the break-even price. If your tax rate is 35 percent and you require a 14 percent on your
investment, complete the following table and verify whether Siri is right.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
1. Capital investment and disposal
Depreciation
2. Change in working capital
Working capital
3. Sales
4. Cost of goods sold-xed
5. Cost of goods sold-variable
Other costs (opportunity cost)
6. Tax
7. Operating cash ow (3 - 4 - 5 - 6)
8. Net cash ow (1 + 2 + 7)
9. Present value
(discount rate = 14%)
Net present value = - - - - -
ANS:
Siri is right. The dollar amount in the following table is in thousands.
1
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
1. Capital investment and disposal -830 39
Depreciation 166 166 166 166 166
2. Change in working capital -75 75
Working capital 75 75 75 75 75 0
3. Sales 1604.2 1604.2 1604.2 1604.2 1604.2
4. Cost of goods sold-xed 210 210 210 210 210
5. Cost of goods sold-variable 1105 1105 1105 1105 1105
Other costs (opportunity cost) 0 0 0 0 0
EBT 123.2 123.2 123.2 123.2 123.2
6. Tax 43.12 43.12 43.12 43.12 43.12
7. Operating cash ow (3 - 4 - 5 - 6) 246.08 246.08 246.08 246.08 246.08
8. Net cash ow (1 + 2 + 7) -905 246.08 246.08 246.08 246.08 360.08
9. Present value -905 215.86 189.35 166.10 145.70 187.01
(discount rate = 14%)
Net present value = 0 - - - - -