Romo Enterprises needs someone to supply it with 121,000 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 $880,000 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 $71,000. Your fixed production costs will be $326,000 per year, and your variable production costs should be $10.40 per carton. You also need an initial investment in net working capital of $76,000. If your tax rate is 30 percent and you require a return of 11 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
5.16
213
To determine the bid price, we need to compute the present value of the costs and cash flows associated with the project.
1. Compute the annual cash outflows:
- Equipment cost: $880,000
- Depreciation per year: $880,000 / 5 years = $176,000
- Fixed production costs: $326,000
- Total annual cash outflows: Depreciation + Fixed production costs = $176,000 + $326,000 = $502,000
2. Compute the variable production costs per year:
- Variable production costs per carton: $10.40
- Number of cartons per year: 121,000
- Total variable production costs per year: Variable production costs per carton * Number of cartons per year = $10.40 * 121,000 = $1,259,600
3. Compute the annual cash inflows:
- Salvage value: $71,000 (after 5 years)
4. Compute the net working capital:
- Initial investment in net working capital: $76,000
5. Compute the annual after-tax cash flows:
- After-tax cash flows = (Annual cash inflows - Annual cash outflows) * (1 - Tax rate)
- Annual after-tax cash flows = (Annual cash inflows - Annual cash outflows) * (1 - 0.30)
6. Compute the present value of the after-tax cash flows:
- Present value of each annual after-tax cash flow = Annual after-tax cash flow / (1 + Required return)^n
- n = number of years
7. Compute the present value of the salvage value:
- Present value of salvage value = Salvage value / (1 + Required return)^n
- n = number of years
8. Compute the present value of the net working capital:
- Present value of net working capital = Net working capital / (1 + Required return)^n
- n = number of years
9. Compute the bid price:
- Bid price = Present value of all cash flows
Let's calculate the bid price step by step.
Step 1: Calculate the annual after-tax cash flow for each year:
Year 1:
Annual after-tax cash flow = ($1,259,600 - $502,000) * (1 - 0.30)
Year 2-5:
Annual after-tax cash flow = ($1,259,600 - $326,000) * (1 - 0.30)
Step 2: Calculate the present value of the after-tax cash flows for each year:
Present value of each annual after-tax cash flow = Annual after-tax cash flow / (1 + Required return)^n
Step 3: Calculate the present value of the salvage value:
Present value of salvage value = Salvage value / (1 + Required return)^n
Step 4: Calculate the present value of the net working capital:
Present value of net working capital = Net working capital / (1 + Required return)^n
Step 5: Calculate the bid price:
Bid price = Present value of all cash flows
Now, let's calculate the bid price using the given information:
Step 1:
Year 1:
Annual after-tax cash flow = ($1,259,600 - $502,000) * (1 - 0.30)
Year 2-5:
Annual after-tax cash flow = ($1,259,600 - $326,000) * (1 - 0.30)
Step 2:
Calculate the present value of the after-tax cash flows for each year.
Step 3:
Calculate the present value of the salvage value.
Step 4:
Present value of net working capital = $76,000 / (1 + 0.11)^5
Step 5:
Calculate the bid price by summing all the present values.
Finally, round your answer to 2 decimal places and submit it as your bid price.