Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2816664 • 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 150,000 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 $1,900,000 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 $160,000. Your fixed production costs will be $275,000 per year, and your variable production costs should be $9.50 per carton. You also need an initial investment in net working capital of $140,000. The tax rate is 40 percent and you require a return of 12 percent on your investment. Assume that the price per carton is $17.00.
Calculate the project NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the minimum number of cartons per year that can be supplied and still break even? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
What is the highest fixed costs that could be incurred and still break even? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a.Calculate the project NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.What is the minimum number of cartons per year that can be supplied and still break even? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
c.What is the highest fixed costs that could be incurred and still break even? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
a) Initial investment: Cost of equipment 1900000 Net working capital 140000 Initial investment 2040000 Annual sales revenue (150000*17) $ 25,50,000.00 Variable cost (150000*9.5) $ 14,25,000.00 Fixed cost $ 2,75,000.00 Depreciation (1900000/5) $ 3,80,000.00 Annual operating income $ 4,70,000.00 Tax at 40% $ 1,88,000.00 NOPAT $ 2,82,000.00 Add: Depreciation $ 3,80,000.00 Annual OCF $ 6,62,000.00 Terminal after tax non-operating cash flows: After tax salvage value = 160000*0.60 = $ 96,000.00 Recovery of NWC $ 1,40,000.00 Terminal after tax non-operating cash flows $ 2,36,000.00 NPV: PV of annual OCF = 662000*(1.12^5-1)/(0.12*1.12^5) = $ 23,86,361.85 PV of terminal cash flows = 236000/1.12^5 = $ 1,33,912.74 Total PV of cash inflows $ 25,20,274.58 Less: Initial investment $ 20,40,000.00 NPV $ 4,80,274.58 b) The question does not say whether it is accounting breakeven or "Zero" NPV. Solution for Zero NPV: For 0 NPV, the PV of cash inflows after tax should be less by 480274.58. So, the annual OCF should be less by 480274.58*0.12*1.12^5/(1.12^5-1) = $ 1,33,232.84 This would be the decrease in after tax contribution. So before tax contribution decrease would be 133232.84/0.60 = $ 2,22,054.73 Number of cartons that can be lost = 222054.73/(17.00-9.50) = 29607 Therefore, minimum number of cartons required for 0 NPV = 150000-29607 = 120393 CHECK: Initial investment: Cost of equipment 1900000 Net working capital 140000 Initial investment 2040000 Annual sales revenue (120393*17) $ 20,46,681.00 Variable cost (120393*9.5) $ 11,43,733.50 Fixed cost $ 2,75,000.00 Depreciation (1900000/5) $ 3,80,000.00 Annual operating income $ 2,47,947.50 Tax at 40% $ 99,179.00 NOPAT $ 1,48,768.50 Add: Depreciation $ 3,80,000.00 Annual OCF $ 5,28,768.50 Terminal after tax non-operating cash flows: After tax salvage value = 160000*0.60 = $ 96,000.00 Recovery of NWC $ 1,40,000.00 Terminal after tax non-operating cash flows $ 2,36,000.00 NPV: PV of annual OCF = 528768.50*(1.12^5-1)/(0.12*1.12^5) = $ 19,06,092.11 PV of terminal cash flows = 236000/1.12^5 = $ 1,33,912.74 Total PV of cash inflows $ 20,40,004.84 Less: Initial investment $ 20,40,000.00 NPV $ 4.84 Almost 0 c) Highest fixed cost for Zero NPV: Existing fixed costs + 222054.73 = $ 4,97,054.73 CHECK: Initial investment: Cost of equipment 1900000 Net working capital 140000 Initial investment 2040000 Annual sales revenue (150000*17) $ 25,50,000.00 Variable cost (150000*9.5) $ 14,25,000.00 Fixed cost $ 4,97,054.73 Depreciation (1900000/5) $ 3,80,000.00 Annual operating income $ 2,47,945.27 Tax at 40% $ 99,178.11 NOPAT $ 1,48,767.16 Add: Depreciation $ 3,80,000.00 Annual OCF $ 5,28,767.16 Terminal after tax non-operating cash flows: After tax salvage value = 160000*0.60 = $ 96,000.00 Recovery of NWC $ 1,40,000.00 Terminal after tax non-operating cash flows $ 2,36,000.00 NPV: PV of annual OCF = 528767.16*(1.12^5-1)/(0.12*1.12^5) = $ 19,06,087.27 PV of terminal cash flows = 236000/1.12^5 = $ 1,33,912.74 Total PV of cash inflows $ 20,40,000.01 Less: Initial investment $ 20,40,000.00 NPV $ 0.01