Question

To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial break-even level for the project. This type of analysis can be extended to many other types of problems. Martin Enterprises needs someone to supply it with 133,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you've decided to bld on the contract. It will cost you $950,000 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 $109,000. Your fixed production costs will be $525,000 per year, and your variable production costs should be $18.15 per carton. You also need an initial Investment In net working capital of $106.000. Assume your tax rate is 23 percent and you require a return of 11 percent on your Investment a. Assuming that the price per carton is $27.60, what is the NPV of this project? (Do not round Intermediate calculations and round your answer to 2 decimal places, e.g.. 3216.) b. Assuming that the price per carton is $27.60, find the quantity of cartons per year you can supply and still break even. (Do not round Intermediate calculations and round your answer to the nearest whole number, e.g. 32) C. Assuming that the price per carton is $27.60, find the highest level of fixed costs you could afford each year and still break even. (Do not round Intermediate calculations and round your answer to 2 decimal places, e.g., 3216.) a. NPV b. Break-even number of cartons c. Break-even fixed costs

Answer 1

a)

Martin	0	1	2	3	4	5
Investment	-$950,000
NWC	-$106,000					$106,000
Salvage						$109,000
Sales		$3,670,800	$3,670,800	$3,670,800	$3,670,800	$3,670,800
VC		-$2,413,950	-$2,413,950	-$2,413,950	-$2,413,950	-$2,413,950
FC		-$525,000	-$525,000	-$525,000	-$525,000	-$525,000
Depreciation		-$190,000	-$190,000	-$190,000	-$190,000	-$190,000
EBT		$541,850	$541,850	$541,850	$541,850	$541,850
Tax (23%)		-$124,626	-$124,626	-$124,626	-$124,626	-$124,626
Net Income		$417,225	$417,225	$417,225	$417,225	$417,225
Cash Flows	-$1,056,000	$607,225	$607,225	$607,225	$607,225	$797,155
NPV	$1,300,953.43

Depreciation = Investment / 5,

Cash Flows = Investment + NWC + Salvage x (1 - tax rate) + Net Income + Depreciation

NPV can be calculated using the same function in excel or calculator with 11% discount rate.

b) Using trial and error method, we need to find quantity such that NPV is almost zero.

We get when quantity = 84,626, we get NPV = 0

c) Similarly, when FC = 982,142, we get NPV = 0.