Question

Your company has been approached to bid on a contract to sell 20,000 voice recognition (VR) computer keyboards per year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $4,100,000 and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $145,000 to be returned at the end of the project, and the equipment can be sold for $265,000 at the end of production. Fixed costs are $800,000 per year and variable costs are $44 per unit. In addition to the contract, you feel your company can sell 4,700, 12,300, 14,300, and 7,600 additional units to companies in other countries over the next four years, respectively, at a price of $125. This price is fixed. The tax rate is 24 percent, and the required return is 13 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $200,000. What bid price should you set for the contract? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

VR	0	1	2	3	4
Unit Sales		4,700	12,300	14,300	7,600
Investment	-$4,100,000
NWC	-$145,000				$145,000
Salvage					$265,000
Sales		$3,043,900	$3,993,900	$4,243,900	$3,406,400
VC		-$1,086,800	-$1,421,200	-$1,509,200	-$1,214,400
FC		-$800,000	-$800,000	-$800,000	-$800,000
Depreciation		-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000
EBT		$132,100	$747,700	$909,700	$367,000
Tax (24%)		-$31,704	-$179,448	-$218,328	-$88,080
Net Profit		$100,396	$568,252	$691,372	$278,920
Cash Flows	-$4,245,000	$1,125,396	$1,593,252	$1,716,372	$1,650,320
NPV	$200,379.74

Sales in year 1 = 4,700 x 125 + 20,000 x P, where P is the bid price

VC = (20,000 + 4,700) x 44 = 1,086,800

Depreciation = 4,100,000 / 4 = 1,025,000

Cash Flows = Investment + NWC + Salvage x (1 - tax) + Net Profit + Depreciation

NPV can be calculated using the same function in excel using 13% discount rate.

We need to find bid price, P such that NPV at least $200,000.

Using trial and error method, we get when P = 122.82, NPV > 200,000