Question

Hassle-Free Web is bidding to provide web hosting services for Hotel Lisbon. Hotel Lisbon pays its current provider $10,400 per year for hosting its web page, handling transactions, etc. Hassle-Free figures that it will need to purchase equipment worth $14,800 up front and then spend $1,800 per year on monitoring, updates, and bandwidth to provide the service for 33 years. If Hassle-Free's cost of capital is 9.7 %, can it bid less than $10,400 per year to provide the service and still increase its value by doing so?

Hassle-Free can bid as low as $?

Answer 1

PV of outflows	= Purchase cost upfront + PV of annual maintenance
PV of annuity for making pthly payment
P = PMT x (((1-(1 + r) ^- n)) / i)
Where:
P = the present value of an annuity stream
PMT = the dollar amount of each annuity payment
r = the effective interest rate (also known as the discount rate)
i=nominal Interest rate
n = the number of periods in which payments will be made
Price of Bond
PV of annual maintenance=	PMT x (((1-(1 + r) ^- n)) / i)
PV of annual maintenance=	1800 * (((1-(1 + 9.7%) ^- 33)) / 9.7%)
PV of annual maintenance=	17,682.35
PV of outflows	= Purchase cost upfront + PV of annual maintenance
PV of outflows	= 14800 + 17,682.35
PV of outflows	32,482.35
PV of annual bid should be atleast equal to PV of outflow
PV of annual revenue=	PMT x (((1-(1 + r) ^- n)) / i)
PV of annual revenue=	Annual Revenue * (((1-(1 + 9.7%) ^- 33)) / 9.7%)
32,482.35	Annual Revenue * (((1-(1 + 9.7%) ^- 33)) / 9.7%)
32,482.35	Annual Revenue * 9.823
Annual Revenue=	32482.35/9.823
Annual Revenue=	3,307
So Hassel free can bid as low as 3,307. Any bid more than 3307 will increase its value