Question

Your company has been approached to bid on a contract to sell 4,950 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.4 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 $410,000 to be returned at the end of the project, and the equipment can be sold for $335,000 at the end of production. Fixed costs are $585,000 per year, and variable costs are $78 per unit. In addition to the contract, you feel your company can sell 12,000, 14,100, 18,200, and 10,700 additional units to companies in other countries over the next four years, respectively, at a price of $179. This price is fixed. The tax rate is 23 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 $150,000. 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

Tax rate		23%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4		Total
Cost		$    3,400,000	$   3,400,000	$    3,400,000	$    3,400,000
Dep Rate (1/4=25%)		25.00%	25.00%	25.00%	25.00%
Depreciation	Cost * Dep rate	$       850,000	$      850,000	$       850,000	$       850,000		$    3,400,000
Calculation of after-tax salvage value
Cost of machine			$   3,400,000
Depreciation			$   3,400,000
WDV	Cost less accumulated depreciation	$                -
Sale price			$      335,000
Profit/(Loss)	Sale price less WDV	$      335,000
Tax	Profit/(Loss)*tax rate	$        77,050
Sale price after-tax	Sale price less tax		$      257,950
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4
No of units		12,000	14,100	18,200	10,700
Selling price		$              179	$             179	$              179	$              179
Operating ost		$                78	$               78	$                78	$                78
Sale		$    2,148,000	$   2,523,900	$    3,257,800	$    1,915,300
Less: Operating Cost		$       936,000	$   1,099,800	$    1,419,600	$       834,600
Less: Additional operating Cost for bidding units	4950*78	$       386,100	$      386,100	$       386,100	$       386,100
Contribution (Sale-operating cost-additional operating cost)	$       825,900	$   1,038,000	$    1,452,100	$       694,600
Less: Fixed cost		$       585,000	$      585,000	$       585,000	$       585,000
Less: Depreciation		$       850,000	$      850,000	$       850,000	$       850,000
Profit before tax (PBT)		$     (609,100)	$     (397,000)	$         17,100	$     (740,400)
Tax@23%	PBT*Tax rate	$     (140,093)	$       (91,310)	$           3,933	$     (170,292)
Profit After Tax (PAT)	PBT - Tax	$     (469,007)	$     (305,690)	$         13,167	$     (570,108)
Add Depreciation	PAT + Dep	$       850,000	$      850,000	$       850,000	$       850,000
Cash Profit after-tax		$       380,993	$      544,310	$       863,167	$       279,892
Calculation of NPV
						11.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$ (3,400,000)	$     (410,000)		$ (3,810,000)	1.0000	$ (3,810,000)
1				$       380,993	$       380,993	0.9009	$       343,237
2				$       544,310	$       544,310	0.8116	$       441,774
3				$       863,167	$       863,167	0.7312	$       631,140
4		$       257,950	$      410,000	$       279,892	$       947,842	0.6587	$       624,373
					Net Present Value	$ (1,769,476)
NPV from outside selling	$    1,769,475.70
NPV required from complete project	$       150,000.00
Total NPV required	$    1,919,475.70
So we will need after tax NPV of bid price equal to $ 1,919,475.70
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