Question

Martin Enterprises needs someone to supply it with 117,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and youâve decided to bid on the contract. It will cost you $780,000 to install the equipment necessary to start production; youâll depreciate this cost straight-line to zero over the projectâs life. You estimate that, in five years, this equipment can be salvaged for $128,000. Your fixed production costs will be $405,000 per year, and your variable production costs should be $10.00 per carton. You also need an initial investment in net working capital of $67,000. If your tax rate is 23 percent and you require a return of 11 percent on your investment, what bid price should you submit?

Answer 1

Answer:

$12,388,753

Explanation:

Assuming X is the amount I will be break even, then my P&L in 5 years as followings:

Fixed production costs: $2,025,000 =$405,000 x 5 years

Variable production cost: $5,850,000 = $10 x 117,000 cartons x 5 years

Initial investment in net working capital: $67,000

Net cost of equipment = cost of instalment $780,000  - Equipment Salvaged $128,000 = $652,000

Tax rate 23%

X = (Fixed production costs of $2,025,000 + Variable production cost of $5,850,000 + Initial investment in net working capital of $67,000 - Net cost of equipment $652,000)/(1-23%) = $11,161,039

If required rate of return is 11%, then the bid price must be $12,388,753 at least = $11,161,039x (1+11%)