Question

Your company has been approached to bid on a contract to sell 4,300 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.9 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 $96,000 to be returned at the end of the project, and the equipment can be sold for $276,000 at the end of production. Fixed costs are $641,000 per year, and variable costs are $156 per unit. In addition to the contract, you feel your company can sell 9,600, 10,500, 12,600, and 9,900 additional units to companies in other countries over the next four years, respectively, at a price of $315. 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.)

Bid price

$

Answer 1

1]	The price should be set such that the NPV is at least $100,000.
2]	The PV of the known cash flows are:
	Equipment cost	$ (3,900,000)
	Net working capital investment	$         (96,000)
	PV of after tax salvage value of equipment = 276000*(1-30%)/1.11^4 =	$         127,267
	PV of recaptured NWC = 96000/1.11^4 =	$           63,238
	PV of depreciation tax shield = (3900000/4)*30%*(1.11^4-1)/(0.11*1.11^4) =	$         907,465
	PV of after tax fixed costs = -641000*(1-30%)*(1.11^4-1)/(0.11*1.11^4) =	$ (1,392,067)
	PV of after tax contribution margin on additional units is calculated below:
		0	1	2	3	4
	Additional units sold		9600	10500	12600	9900
	After tax total contribution margin [(315-156)*(1-30%)=111.3 per unit]		$      1,068,480	$        1,168,650	$     1,402,380	$    1,101,870
	PVIF at 11%	1	0.90090	0.81162	0.73119	0.65873
	PV at 11%		$          962,595	$           948,503	$     1,025,408	$       725,836
	Sum of PV of after tax contribution margin from addl. Units	$     3,662,341
	After tax variable costs of units under contract = -4300*156*(1-30%)*(1.11^4-1)/(0.11*1.11^4) =	$   (1,456,784)
	Sum of PV of known cash flows	$   (2,084,540)
	Less: Minimum NPV required	$         100,000
	PV required from after tax sale price of the 4300 units	$   (2,184,540)
2]	Equivalent annual value of PV of after tax sale value = 2184540*0.11*1.11^4/(1.11^4-1) =	$         704,135
	Before tax sale value = 704135/(1-30%) =	$     1,005,907
3]	Bid price for the contract = 1005907/4300 =	$           233.93
	Answer: Bid price = $233.93/Unit