You have got a contract to sell 17,500 keyboards a year for four years. No sales
ID: 2701894 • Letter: Y
Question
You have got a contract to sell 17,500 keyboards a year for four years. No sales will be possible thereafter. The equipment 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 $95,000 to be returned at the end of the project. The equipment can be sold for $275,000 at the end of production. Fixed costs are $600,000 per year, and variable costs are $175 per unit. In addition to the contract, you can sell 3,000, 6,000, 8,000, and 5,000 additional units to companies in other countries over the next four years, respectively, at a price of $285. This price is fixed. The tax rate is 40%, and the required return is 13%. Your company will undertake the project only if it has an NPV of $100,000. What will be your bid price for the contract?Explanation / Answer
Present Value from additional unit to companies = ((285-175)*0.60*3000)/1.13 + ((285-175)*0.60*6000)/(1.13)^2 + ((285-175)*0.60*8000)/(1.13)^3 + ((285-175)*0.60*5000)/(1.13)^4
=$1053673
let the bid price be x
NPV =(17500*(X-175)-600,000)*0.60PVIFA(13%,4) + 850000*0.4 PVIFA(13%,4) + 275000*0.60/(1.13)^4 + 95000/(1.13)^4 + 1053673- 3,400,000-95000
100,000 = (17500*(x-175)-600,000)*0.60* 2.9745 + 340000*2.9745 %u2013 2,281,869
(17500*(x-175)-600,000)*0.60* 2.9745 = 1,370,539
17500*(x-175) = 1370539/(0.6*2.9745) +600,000
x-175 = 1,367,938/17500
x = 78.17 + 175 = $253.17
What will be your bid price for the contract?
Minimum Bid price will be $253.17 per unit
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