Your company has been approached to bid on a contract to sell 4,200 voice recogn

Question

Your company has been approached to bid on a contract to sell 4,200 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.8 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 $95,000 to be returned at the end of the project, and the equipment can be sold for $275,000 at the end of production. Fixed costs are $640,000 per year, and variable costs are $155 per unit. In addition to the contract, you feel your company can sell 9,500, 10,400, 12,500, and 9,800 additional units to companies in other countries over the next four years, respectively, at a price of $310. 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?

Explanation / Answer

After Tax salvage value = 275000*(1-40%) = $165,000 we have CF0 = Eqpt cost + Inc in Wrkg Cap = 3,800,000+95000 = $3,895,000 We have Cash Inflow in Y1 to Y4 as below (In addition to Cash IF from 4200 units pa):- AY1 : 9500*($310-155) = $1,472,500 AY2: 10400*($310-155)= $1,612,000 AY3: 12500*($310-155) = $1,937,500 In AY4, we have Cash Inflow of Addl Units + ATax Salave + recovery of Wrkg Cap = 9800*($310-155) + 165000+95000 = $1,779,000 So PV of these CFs = CF0+AY1/(1+r) + AY2/(1+r)^2 + AY3/(1+r)^3+AY4/(1+r)^4 = -3895000 + 1472500/(1+10%)^1+1612000/(1+10%)^2 + 1937500/(1+10%)^3 + 1937500/(1+10%)^4 = $1,554,879 So OCF = PMT(Rate,nper,PV,FV) = PMT(10%,4,1554879,0) = $490,519 Now, using OCF = (Sales - Costs) *(1 - T) + Depr * T Depr = (3,800,000-95000)/ 4 = $926,250 Costs = FC + VC *Q = 640,000 + 155*4200 = $1,291,000 solve for sales: Sales = ( OCF - Depr x T + Costs x (1 - T) ) / (1 - T) = (490519 - 926250*40% + 1291000*(1-40%)/(1-40%) = $1,411,019 This is Sale of 4200 units So Bid price for contrcat is $1,411,019 & per unit price = $1,411,019/4200 = $336

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