Your company has been approached to bid on a contract to sell 4,300 voice recogn

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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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?

Explanation / Answer

Bid price (if fixed costs of $ 641000 is incurred irrespective of the contract :

Expenses towards depreciation for 4300 units = $ 634200.

Per unit depreciation = 634200 /4300 = $ 147.49

Add: variable cost per unit = $ 156

So bid price = $ 303.49

Year 1 $ Year 2 $ Year 3 $ Year 4 $ Sales (quantity) 9600 10500 12600 9900 Cost per unit 315 315 315 315 Sale price 3024000 3307500 3969000 3118500 Fixed costs 641000 641000 641000 641000 Variable costs per unit 156 156 156 156 Variable costs 1497600 1638000 1965600 1544400 Total outflows 2138600 2279000 2606600 2185400 Salvage value 276000 Tax effect @ 30% on Depreciation = 906000 271800

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