Question

Your company has been approached to bid on a contract to sell 5,450 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $4.4 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 $460,000 to be returned at the end of the project, and the equipment can be sold for $435,000 at the end of production. Fixed costs are $635,000 per year, and variable costs are $88 per unit. In addition to the contract, you feel your company can sell 14,000, 16,100, 19,200, and 11,700 additional units to companies in other countries over the next four years, respectively, at a price of $196. This price is fixed. The tax rate is 23 percent, and the required return is 9 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?

Answer 1

Les's calculate the PV from sale to other countries
Tax rate		23%
	Year-0	Year-1	Year-2	Year-3	Year-4
Units		14,000	16,100	19,200	11,700
Sale Price		196	196	196	196
variable cost		88	88	88	88
Sale		2,744,000	3,155,600	3,763,200	2,293,200
Less: Operating Cost		1,232,000	1,416,800	1,689,600	1,029,600
Contribution		1,512,000	1,738,800	2,073,600	1,263,600
Less: Fixed Cost		635,000	635,000	635,000	635,000
Less: Depreciation as per table given below		1,100,000	1,100,000	1,100,000	1,100,000
Profit before tax		(223,000)	3,800	338,600	(471,400)
Tax		(51,290)	874	77,878	(108,422)
Profit After Tax		(171,710)	2,926	260,722	(362,978)
Add Depreciation		1,100,000	1,100,000	1,100,000	1,100,000
Cash Profit After tax		928,290	1,102,926	1,360,722	737,022
Cost of machine			4,400,000
Depreciation			4,400,000
WDV			-
Sale price			435,000
Profit/(Loss)			435,000
Tax			100,050
Sale price after tax			334,950
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		4,400,000	4,400,000	4,400,000	4,400,000
Dep Rate		25.00%	25.00%	25.00%	25.00%
Deprecaition		1,100,000	1,100,000	1,100,000	1,100,000		4,400,000
Calculation of NPV
						9.00%
Year		Captial	Working captial	Operating cash	Annual Cash flow	PV factor	Present values
0		(4,400,000)	(460,000)		(4,860,000)	1.000	(4,860,000)
1				928,290	928,290	0.917	851,642
2				1,102,926	1,102,926	0.842	928,311
3				1,360,722	1,360,722	0.772	1,050,727
4		334,950	460,000	737,022	1,531,972	0.708	1,085,288
					Net Present Value		(944,032)
Without contract NPV	(944,032)
Required NPV	100,000
NPV required from contract	1,044,032
Sum of PV factor from Year 1-4	3.240
Annual additional cash flow required from contract	1044032/3.240	322,232.10
Pretax contribution required	322232.10/(1-23%)	418,483.25
Per unit contribution required	418483.25/5450	76.79
Variable cost per unit	88
Price quotation	164.79