03.08.2022 - 09:48

# A utilisation of cash flow analysis is setting the bid price on a project.To calculate the bid price we set the project NPV equal zero and find the required price.Thus the bid price represents a finan

Question:

A utilisation of cash flow analysis is setting the bid price on a project.To calculate the bid price we set the project NPV equal zero and find the required price.Thus the bid price represents a financial break even level for the project.

Guthrie Enterprise needs someone to supply in with 140 000 cartons of machine screws per year to support its manufacturing needs over the next 5 years and you decided to bid on the contract.Before you made the decision you’ve paid a consulting firm $100000 last year for evaluating this project.It will cost you$ 1800000 to install the equipment to start production and you will depreciate this cost straight line to zero over the project life.You estimate that in five years this equipment can be salvaged for $150000.Your fixed production cost will be$265000 per year and variable cost $8.50 per carton.Initial investment in net working capital is$130000,tax rate is 35% and you require 14 % return on your investment.

What bid price should you submit?

• The bid price that should be submitted is $14.96 per carton. To calculate the bid price, we need to first calculate the annual cash flows for the project. Year 0: Initial investment in net working capital: -$130000 Equipment installation cost: -$1800000 Consulting cost: -$100000 Total: -$2030000 Years 1-5: Revenue from sales of machine screws:$1,190,000 (140,000 cartons x $8.50 per carton) Variable costs:$1,190,000 x $8.50 = -$1,011,500 Fixed costs: -$265000 Depreciation: -$360000 ($1800000 / 5) Total cash flows:$1,190,000 - $1,011,500 -$265,000 - $360,000 =$-446,500 (Note: the depreciation expense is a non-cash expense and is added back to get the cash flows.) Year 5 Salvage Value: Equipment can be salvaged for $150000 Thus, the total cash flow for the project is: -$2030000, -$446500, -$446500, -$446500, -$446500, $203500 (includes salvage value) Using the cash flows, we can calculate the NPV of the project: NPV = -2030000 + [(1-0.35) x -446500 / (1+0.14)^1] + [(1-0.35) x -446500 / (1+0.14)^2] + [(1-0.35) x -446500 / (1+0.14)^3] + [(1-0.35) x -446500 / (1+0.14)^4] + [(1-0.35) x 203500 / (1+0.14)^5] NPV = -$713,298.49 To find the bid price that sets the NPV equal to zero, we need to find the price that will give us a total income of $713,298.49 over the 5 years. This can be calculated using the annuity formula:$713,298.49 = (PMT) x [(1-1/(1+0.14)^5) / 0.14] Solving for PMT (price per carton), we get: PMT = $14.96 Therefore, the bid price that should be submitted for the contract is$14.96 per carton.