Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2742113 • 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 153,000 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 $1,930,000 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 $163,000. Your fixed production costs will be $278,000 per year, and your variable production costs should be $9.80 per carton. You also need an initial investment in net working capital of $143,000. If your tax rate is 38 percent and you require a return of 10 percent 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.)
Explanation / Answer
Initial Investment= Annual Cash Saving*(1-(1+r)^-n)/r + Post Tax Salvage Value/(1+r)^n + Working capital/(1+r)^n
Annual Cash Saving =(Initial Investment - (Post Tax Salvage Value/(1+r)^n + Working capital/(1+r)^n))/((1-(1+r)^-n)/r)
Annual Cash Saving = (1930000+143000 - (163000*(1-38%)/(1+10%)^5 + 143000/(1+10%)^5))/((1-(1+10%)^-5)/10%)
Annual Cash Saving = $ 506,875.76
Annual Cash Saving = ((Bid price - variable production costs)*No of Unit - fixed production costs)*(1-tax rate) + Annual Depreciation*tax rate
506,875.76 = ((Bid price - 9.80)*153000- 278000)*(1-38%) + 1930000/5 *38%
((506,875.76 - 146680)/62% + 278000)/153000 + 9.80 = Bid price
Bid price = $ 15.41
Answer
Bid price = $ 15.41