Question

Your company has been approached to bid on a contract to sell 4,850 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $400,000 to be returned at the end of the project, and the equipment can be sold for $315,000 at the end of production. Fixed costs are $575,000 per year, and variable costs are $76 per unit. In addition to the contract, you feel your company can sell 11,600, 13,700, 18,000, and 10,500 additional units to companies in other countries over the next four years, respectively, at a price of $172. This price is fixed. The tax rate is 21 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

Operating cash flow (OCF) each year = income after tax + depreciation

In year 4, the entire working capital investment is recovered.

profit on sale of equipment at end of year 4 = sale price - book value

book value = original cost - accumulated depreciation

book value is zero as the equipment is fully depreciated

after-tax salvage value = salvage value - tax on profit on sale of equipment

NPV is calculated using NPV function in Excel

First, we assume the bid price is $120 and calculate the NPV

NPV is -$221,664

Next, we use GoalSeek in Excel to find the bid price at which NPV is $100,000

The bid price should be $145.91