Question

You are considering setting up a software development business.   To set up the enterprise you will need to buy equipment costing $100,000. This equipment will be depreciated straight line over 5 years to a zero salvage value. Its market value at the end of the 5 years will be zero.   You will need to rent space at $5,000 per year for the five years of the project. You will also need to hire 5 software engineers at $50,000 each, per year to work in this project. Marketing and selling costs will be $100,000 per year during the project. Materials costs are $20 per unit. You expect to sell 6,000 units of the product each year for the five years. If your tax rate is 40%, and you require a return of 12%, what is the minimum price you should charge per unit of the product?

Answer 1

Year	1	2	3	4	5
Sales (6000 units * $85.83 per unit )	$       5,15,000	$       5,15,000	$       5,15,000	$       5,15,000	$       5,15,000
Materials costs (6000 units * $20 per unit )	$       1,20,000	$       1,20,000	$       1,20,000	$       1,20,000	$       1,20,000
Salary Cost (5 engineers at $ 50000 each)	$       2,50,000	$       2,50,000	$       2,50,000	$       2,50,000	$       2,50,000
Rent	$             5,000	$             5,000	$             5,000	$             5,000	$             5,000
Marketing and selling costs	$       1,00,000	$       1,00,000	$       1,00,000	$       1,00,000	$       1,00,000
Depereciation (equipment Cost / life of the asset)	$           20,000	$           20,000	$           20,000	$           20,000	$           20,000
Eearning Before Tax (EBT)	$           20,000	$           20,000	$           20,000	$           20,000	$           20,000
Tax @ 40%	$             8,000	$             8,000	$             8,000	$             8,000	$             8,000
Eearning After Tax (EAT)	$           12,000	$           12,000	$           12,000	$           12,000	$           12,000
We require a return of 12% on the Investment we made i.e. $100000 @ 12% we require to generate EAT $12000
We can use the formula is as follows :
Sale Price per unit = Total Annual cost + (Desired EAT / 1-tax rate)/No of unit Sell
=(495000+(12000/0.6))/6000	$      85.83	$      85.83	$      85.83	$      85.83	$      85.83