Another utilization of cash flow analysis is setting the bid price on a project.
ID: 2821286 • 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 159,000 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 $1,990,000 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 $169,000. Your fixed production costs will be $284,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $149,000. The tax rate is 40 percent and you require a return of 13 percent on your investment. Assume that the price per carton is $17.90.
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?
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 159,000 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 $1,990,000 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 $169,000. Your fixed production costs will be $284,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $149,000. The tax rate is 40 percent and you require a return of 13 percent on your investment. Assume that the price per carton is $17.90.
Explanation / Answer
a. Calculation of NPV
The depreciation expense will not be included in NPV since it is a non cash expense.
The investment in the project = $ 1,990,000
We now need to calculate net cash inflow which we will use in calculation of NPV. To calculate that, we need to subtract the annual expenses from annual income.
Annual Expenses are divided in two parts: Fixed and Variable.
Fixed expense per annum = $ 284,000
Variable expense per annum = $10.40 *159,000 = $ 1,653,600
Hence total expenses per annum = $ 284,000 + $ 1,653,600 = $ 1,937,600
Now Lets calculate annual income = $17.90*159000 = $ 2,846,100
Hence, Net Cash Inflow = $ 2846100 - $ 1937600 = $ 908,500
Now in excel using the NPV function we will substitute the values as follows:
Rate = 13%, Value1 =-$1,990,000(Negative because this is the investment i.e cash outflow), Value 2-Value 6 = $ 908,500 (Annual Cash Inflow as calculated above)
After above calculation, the NPV = $1,066,729.74
b. Breakeven
Breakeven Point (Units) = Fixed Cost /(Revenue per unit - Variable cost per Unit)
Substituting values in above formula,
Breakeven point (Units) = $284,000 / (17.90-10.40) = 37,867 Cartons
c. Highest Fixed cost to break even
Considering Variable costs are same, the highest fixed cost to breakeven can be found out by using goal seek function in excel.
Fixed cost = $284000
Revenue per unit = $17.90
Cost per unit = $ 10.40
Breakeven = 37867 Cartons
Now using Goal seek , Set Breakeven = 159000 cartons (maximum to be delivered in a year)
By chaging the Fixed cost cell, the fixed cost for the breakeven of 159000 cartons comes to be $ 1192500. This is highest fixed cost to breakeven.