To calculate the bid price per carton, we first need to find the net present value (NPV) of the project and then divide it by the total number of cartons to be supplied over the 5-year period. Here are the steps to calculate the NPV:
1. Calculate the initial investment:
The initial investment includes the cost of the new equipment and the initial investment in net working capital, which is $780,000 + $75,000 = $855,000.
2. Calculate the annual depreciation expense:
Depreciation expense = (Cost of equipment - Salvage value) / Life of the equipment
Depreciation expense = ($780,000 - $50,000) / 5 = $146,000
3. Calculate the annual operating cash flows:
Operating cash flows = (Revenue - Costs - Depreciation expense)(1 - Tax rate) + Depreciation expense
Let's assume x as the bid price per carton. Then, the annual revenue would be 150,000 * x.
The total variable costs per annum will be $8.50 * 150,000 = $1,275,000.
Operating cash flows = ((150000 * x) - $1,275,000 - $146,000) * (1 - 0.35) + $146,000
4. Calculate the salvage value of the equipment after tax:
After-tax salvage value = Salvage value * (1 - Tax rate)
After-tax salvage value = $50,000 * (1 - 0.35) = $32,500
5. Calculate the NPV of the project using the cost of capital:
The annual operating cash flows will be received for 5 years, so we can use the annuity formula to find the present value (PV) of these cash flows:
PV = Operating cash flows * ((1 - (1 / (1 + Cost of capital)^5)) / Cost of capital)
PV = Operating cash flows * ((1 - (1 / (1+0.16)^5)) / 0.16)
PV = Operating cash flows * 3.2749 (approx.)
Now, we also need to add the after-tax salvage value of the equipment and subtract the initial investment from the PV to find the NPV:
NPV = PV + After-tax salvage value - Initial investment
NPV = (Operating cash flows * 3.2749) + $32,500 - $855,000
6. Set the NPV to zero and solve for the bid price per carton (x):
0 = ((150000 * x) - $1,275,000 - $146,000) * (1 - 0.35) + $146,000) * 3.2749 + $32,500 - $855,000
0 = 150000 * x * 0.65 * 3.2749 - $578,008.75 (approx.)
Now solve for x:
x = $578,008.75 / (150000 * 0.65 * 3.2749) ≈ $12.53
So, the bid price per carton on this project should be approximately $12.53.
Union America Corporation (UAC) is planning to bid on a project to supply 150,000 cartons of machine screws per year for 5 years to the US NAvy. In order to produce the machine screws UAC would have to buy some new equipment. The new equipment would cost $780,000 to purchase and install. This equipment would be depriciated straight line to zero over the 5 years of the contract. However, UAC thinks it could sell the equipment for $50,000 at the end of year 5. Fixed production costs will be $240,000 per year, and variable costs of production are $8.50 per carton. UAC would also need an initial investment in Net Working Capital of $75,000 at the begining of this project. UAC has a cost of capital of 16% and a tax rate of 35%. What should be the bid price per carton on this project?
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