Question

your company has been approached to bid on a contract to sell 5,050 voice recognition (VR) computer keyboards a year for four years. Due to thehnical improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $3.6 million and will be depreciated on a straight line basis to a zero salvage value. Production will require an investment in the working capital of $355,000 at the end of production. Fixed costs are $595,000 per year, and variable costs are $80 per unit. In addition to the contract, you feel your feel your company can sell 12,400, 14500, 18.400 and 10,900 additional units to companied in other contries over the next four years, respectively, at a price of $180. This price is fixed, the tax rate is 25 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 $125,000. What bid price should you set for the contract?

Answer 1

Step : 1 Calculating Free cash flows
Year	1	2	3	4
Additional sales units	12,400	14,500	18,400	10,900
Sales price p.u.(in $)	180.00	180.00	180.00	180.00
Variable cost p.u.(in $)	80.00	80.00	80.00	80.00
a).Sales value	22,32,000	26,10,000	33,12,000	19,62,000
b).Variable cost	9,92,000	11,60,000	14,72,000	8,72,000
c).Contribution (a-b)	12,40,000	14,50,000	18,40,000	10,90,000
d).Fixed cost	5,95,000	5,95,000	5,95,000	5,95,000
e).Depreciation	9,00,000	9,00,000	9,00,000	9,00,000
f).Income (c-d-e)	-2,55,000	-45,000	3,45,000	-4,05,000
g).Tax @ 25% (f*25%)	-63,750	-11,250	86,250	-1,01,250
h).Net Income (f-g)	-1,91,250	-33,750	2,58,750	-3,03,750
i).Free cashflows (h+e)	7,08,750	8,66,250	11,58,750	5,96,250
Step : 2 Initial outlay
a)Investment in capital equipment =			36,00,000
b)Working capital(will be released in last year of production) =			3,55,000
Initial outlay = (a+b)			39,55,000.00
Depreciation =	36,00,000/4   =	9,00,000
Step : 3 Computing NPV
Year	Cash flows	PV @9%	Disc. Cashflows
1	7,08,750	0.9174	6,50,207.25
2	8,66,250	0.8417	7,29,122.63
3	11,58,750	0.7722	8,94,786.75
4	5,96,250	0.7084	4,22,383.50
4(working capital)	3,55,000	0.7084	2,51,482.00
Discounted cash inflows =			29,47,982.13
	Initial cost =		39,55,000.00
		NPV =	-10,07,018
Minimum NPV expected = $125,000
Therefore, revised NPV = 10,07,018+1,25,000 = $11,32,018
Total units to be supplied through 4 years = 4*5050 = 20,200 units.
Price per unit = 11,32,018/20,200   = $56.04