Concept explainers
a)
To find: The
Introduction:
The price that a buyer is ready to pay for a security is the bid price.
a)
Answer to Problem 34QP
The net present value is $465,254.29.
Explanation of Solution
Given information:
The D enterprise requires someone to supply it with 120,000 cartons of screw machines for one year to support the operations requirements for the subsequent 5 years. Person X has decided to make a bid on the contract. It will charge Person X $870,000 to install the necessary equipment to begin the production. Person X depreciates on a straight-line to zero over the project’s life. The equipment can be salvaged for $70,000.
The cost of fixed production of Person X is $325,000 for a year, and the variable production cost must be $10.30 for a carton. The essential investment that is required by Person X in the net working capital is $75,000. The tax rate is assumed to be 35% and the
Note: To calculate the bid price, it is essential to set the net present value equal to zero and the essential price is found using the operating cash flow. Thus, the bid price is representing the project’s financial break-even level.
Computation of the net present value:
Year | 1 | 2 | 3 | 4 | 5 |
Sales | $2,040,000 | $2,040,000 | $2,040,000 | $2,040,000 | $2,040,000 |
Less: Variable costs | 1,236,000 | 1,236,000 | 1,236,000 | 1,236,000 | 1,236,000 |
Fixed costs | 325,000 | 325,000 | 325,000 | 325,000 | 325,000 |
|
174,000 | 174,000 | 174,000 | 174,000 | 174,000 |
EBIT | $ 305,000 | $ 305,000 | $ 305,000 | $ 305,000 | $ 305,000 |
less: Taxes (35%) | 106,750 | 106,750 | 106,750 | 106,750 | 106,750 |
Net Income | $ 198,250 | $ 198,250 | $ 198,250 | $ 198,250 | $ 198,250 |
Add: Depreciation | 174,000 | 174,000 | 174,000 | 174,000 | 174,000 |
Operating cash flow | $ 372,250 | $ 372,250 | $ 372,250 | $ 372,250 | $ 372,250 |
Year | 1 | 2 | 3 | 4 | 5 |
Operating cash flow | $ 372,250 | $ 372,250 | $ 372,250 | $ 372,250 | $ 372,250 |
Change in NWC | - | - | - | - | 75,000 |
Capital spending | - | - | - | - | 45,500 |
Total CF | $ 372,250 | $ 372,250 | $ 372,250 | $ 372,250 | $ 492,750 |
Computations for the above table:
Formula to calculate the sales:
Computation of the sales:
Formula to calculate the
Computation of the cash outflow:
Formula to calculate the net present value:
Computation of the net present value:
Hence, the net present value is $465,254.29.
Explanation:
The net present value of the project is positive. If the real price is above the bid price, then it shows the results in zero net present value. As for the cartons, if the number of cartons sold increase, then the net present value will increase. Also, if the costs maximizes, the net present value will decline.
b)
To find: The cartons quantity that can be still supplied and still break even.
Introduction:
The price that a buyer is ready to pay for a security is the bid price.
b)
Answer to Problem 34QP
The quantity of the cartons is 90,364.
Explanation of Solution
Given information:
The price per quantity is $17.
Computation of the operating cash flow using the formula of the net present value:
Hence, the operating cash flow is $243,184.0773.
Formula to calculate the tax shield approach:
Computation of the quantity using the formula of the operating cash flow:
Hence, the quantity of the carton is 90,364.
c)
To find: The highest level of the fixed cost that can be afforded and still break even.
Introduction:
The price that a buyer is ready to pay for a security is the bid price.
c)
Answer to Problem 34QP
The highest fixed cost is $523,562.68.
Explanation of Solution
Given information:
The price per quantity is $17, and the number of cartons is 120,000. The fixed price must be more than $325,000.
Computation of the operating cash flow using the formula of the net present value:
Hence, the operating cash flow is $243,184.0773.
Formula to calculate the tax shield approach:
Computation of the fixed cost using the tax shield approach:
Hence, the highest level of fixed cost is $523,562.58.
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