Heer Enterprises needs someone to supply it with 130,000 cartons of machine screws per year to support its manufacturing needs over the next four years, and you've decided to bid on the contract. It will cost you $765,000 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 four years, this equipment can be salvaged for $375,000. Your fixed production costs will be $190,000 per year, and your variable production costs should be $8.20 per carton. You also need an initial investment in net working capital of $59,500, all of which will be recovered when the project ends. Your tax rate is 22 percent and you require a return of 14.5 percent. What bid price per carton should you submit?

Question

Quizplus · Accepted Answer

To find the bid price per carton, we need to calculate the total cost of producing and supplying 130,000 cartons per year for four years, and then divide that by the total number of cartons.

Total cost = equipment cost + fixed production costs + variable production costs + initial investment in net working capital 
Total cost = $765,000 + $190,000 x 4 + $8.20 x 130,000 x 4 + $59,500 
Total cost = $4,735,700

Now we need to discount the salvage value of the equipment at the end of four years back to the present using the required return of 14.5%.

Present value of salvage value = $375,000 / (1 + 0.145) ^ 4 
Present value of salvage value = $212,521

The bid price per carton is therefore:

Bid price per carton = (total cost - present value of salvage value) / total number of cartons 
Bid price per carton = ($4,735,700 - $212,521) / (130,000 x 4) 
Bid price per carton = $11.37

Therefore, the best choice is (C) $11.37, as this is the bid price per carton that will allow the company to earn its required return of 14.5%.

Heer Enterprises Needs Someone to Supply It with 130,000 Cartons