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Estimating the appropriate bid price

Guthrie Enterprises needs someone to supply it with 230,000 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 $1,000,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. Your fixed production costs will be $410,000 per year, and your variable production costs should be $8.50 per carton. You also need an initial investment in net working capital of $60,000. No additional working capital is needed and no working capital will be returned. If your tax rate is 35% and you require a 14% return on your investment, what bid price should you submit?

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Solution Preview

Initial Investment=1,000,000
Net working capital required=60,000
Total initial cash outflow=(1000000+60000)=1,060,000

Depreciation per year=(Initial investment-Salvage)/Useful life=(1000000-0)/5 = 200,000
Fixed Cost per year=410000
Variable cost per year=230000*8.5=1,955,000
Total Cost per ...

Solution Summary

One use of cash flow analysis is setting the bid price on a project. The bid price represents a financial break-even level for the project. Solution to given problem depicts the steps to estimate the appropriate bid price in the given case.