Question

Your company has been approached to bid on a contract to sell 3,600 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.2 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 $89,000 to be returned at the end of the project, and the equipment can be sold for $269,000 at the end of production. Fixed costs are $634,000 per year, and variable costs are $149 per unit. In addition to the contract, you feel your company can sell 8,900, 9,800, 11,900, and 9,200 additional units to companies in other countries over the next four years, respectively, at a price of $280. This price is fixed. The tax rate is 30 percent, and the required return is 11 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $100,000. 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

Answer )

The calculation is based on the concept of NPV ,

NPV = PV ( all net cash inflows) - cash out flow

Here , the net cash inflow will be calculated as (sales inflow - cost - tax - depreciation)

Unit produced in 4 years

	1	2	3	4
Contract Fixed Unit	3600	3600	3600	3600
Sell to others	8900	9800	11900	9200
Total Production	12500	13400	15500	12800

The calculations are being shown below in spread sheet with minimum NPV level of $ 100,000.

Net Cash Flow
	Y0	1	2	3	4
Net Capital Costs
New equipment cost	$        3,200,000
Additional Working capital cost	$            89,000
	$                   -
		$                 -	$                 -	$                 -	$                 -
Total Capital	$       (3,289,000)	$                 -	$                 -	$                 -	$                 -
Operating and Maintenance Costs
Fixed cost		$         634,000	$         634,000	$         634,000	$         634,000
Variable cost (@ 149 per unit)		$      1,862,500	$      1,996,600	$      2,309,500	$      1,907,200
Escalation of Costs
Total Costs	$                   -	$     (2,496,500)	$     (2,630,600)	$     (2,943,500)	$     (2,541,200)
Revenue and Operating Benefits
Sales		$      3,363,482	$      3,615,482	$      4,203,482	$      3,447,482
Benefit 1 ( selling of equipments)					$         269,000
Benefit 2 ( return of working capital					$           89,000
Total Benefits and Revenue	$                   -	$      3,363,482	$      3,615,482	$      4,203,482	$      3,805,482
Cash Flow Before Taxes	$       (3,289,000)	$         866,982	$         984,882	$      1,259,982	$      1,264,282
Income Tax Calculation
Depreciation Expense		$        (800,000)	$        (800,000)	$        (800,000)	$        (800,000)
Operating Cost		$     (2,496,500)	$     (2,630,600)	$     (2,943,500)	$     (2,541,200)
Operating Benefits		$      3,363,482	$      3,615,482	$      4,203,482	$      3,805,482
Net Income Taxes	$                   -	$          (20,095)	$          (55,465)	$        (137,995)	$        (139,285)
Cash Flow After Taxes	$       (3,289,000)	$         946,887	$      1,029,417	$      1,221,987	$      1,224,997
Discounted Cash Flow (After Tax)	$       (3,289,000)	$         853,052	$         835,498	$         893,507	$         806,944
Business Case Results:			Assumptions:
NPV of Cash Flow	$           100,000		Price of bid (per unit)		$242.0783 => $242.08/unit
Profitability Index	1.03		Income Tax Rate		30.00%
			WACC		11.00%