Question

Your company has been approached to bid on a contract to sell 3,700 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.3 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 $90,000 to be returned at the end of the project, and the equipment can be sold for $270,000 at the end of production. Fixed costs are $635,000 per year, and variable costs are $150 per unit. In addition to the contract, you feel your company can sell 9,000, 9,900, 12,000, and 9,300 additional units to companies in other countries over the next four years, respectively, at a price of $285. This price is fixed. The tax rate is 40 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 $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

Solution

Bid Price	$       279.22
	0	1	2	3	4
Unit		9000	9900	12000	9300
Investment	-$ 3,300,000
NWC	-$       90,000				$      90,000
Salvage					$    270,000
Sales		$ 3,598,114	$ 3,854,614	$ 4,453,114	$ 3,683,614
VC		-$1,905,000	-$2,040,000	-$2,355,000	-$1,950,000
FC		-$   635,000	-$   635,000	-$   635,000	-$   635,000
Depreciation		-$   825,000	-$   825,000	-$   825,000	-$   825,000
EBT		$    233,114	$    354,614	$    638,114	$    273,614
Tax (40%)		-$     93,246	-$   141,846	-$   255,246	-$   109,446
Profits		$    139,868	$    212,768	$    382,868	$    164,168
Cash Flows	-$ 3,390,000	$    964,868	$ 1,037,768	$ 1,207,868	$ 1,241,168
NPV	$     100,037

We need to find the bid price such that the NPV of the project is equal to $100,000

Sales (year 1) = 9,000 x 285 + 3,700 x Bid Price

Variable Cost VC (year 1) = 150 x (9000 + 3700) = 1,905,000

FC = 635,000

Depreciation = 3,300,000 / 4 = 825,000

Profits = EBT x (1 - tax rate)

Cash Flows = Profits + Depreciation + Investment + NWC + After-tax salvage value

NPV = NPV(10%, CF1...CF4) + CF0

Start with a bid price of $285.00 and calculate the NPV of the project. If it is much higher than $100,000 decrease the bid price and recalculate the NPV. Using trial and error method or excel solver, we get at bid price = $279.22, the NPV of $100,037.

Hence, you should set a bid price of $279.22 for the contract.