Question

Your company has been approached to bid on a contract to sell 5,500 voice recognition (VR) computer keyboards a 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $4.5 million and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $465,000 to be returned at the end of the project, and the equipment can be sold for $445,000 at the end of production. Fixed costs are $640,000 per year, and variable costs are $89 per unit. In addition to the contract, you feel your company can sell 14,200, 16,300, 19,300, and 11,800 additional units to companies in other countries over the next four years, respectively, at a price of $198. This price is fixed. The tax rate is 24 percent, and the required return is 10 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $125,000. What bid price should you set for the contract?

Answer 1

Let revenue from contract be x

	Year 1	Yr 2	Yr 3	Yr 4
Variable Cost( additional units)	89 * 14200= 1263800	89*16300 = 1450700	89*19300= 1717700	11800*89= 1050200
Variable cost( original contract)	5500 * 89 = 489500	5500 * 89 = 489500	5500 * 89 = 489500	5500 * 89 = 489500
Fixed Cost	640000	640000	640000	640000
Total Cost(A)	2393300	2580200	2847200	2179700
Depreciation cost/year(B)	4500000/4 = 1125000	4500000/4 = 1125000	4500000/4 = 1125000	4500000/4 = 1125000
Salvage value of equipment(C)	0	0	0	445000
NET COSTS(A+B-C)	35,18,300	3705200	3972200	2859700
Revenue from additional sales	14200 * 198 =2811600	16300*198 =3227400	19300*198 =3821400	11800*198 =2336400
Total revenue	2811600 + x	3227400 + x	3821400 + x	2336400 + x
Net revenue	-706700 + x	-477800 + x	-150800 + x	-523300 + x

NPV =

125000=

183012.5 = -714869.45 +1.01156x - 439384.88 + 0.9196x - 126068.8 + 0.836x - 397708 + 0.76x

1861043.63 = 3.52716x

x = 527632.32