Your company has been approached to bid on a contract to sell 4,900 voice recogn
ID: 2712473 • Letter: Y
Question
Your company has been approached to bid on a contract to sell 4,900 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $4.5 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 $102,000 to be returned at the end of the project, and the equipment can be sold for $282,000 at the end of production. Fixed costs are $647,000 per year, and variable costs are $162 per unit. In addition to the contract, you feel your company can sell 10,200, 11,100, 13,200, and 10,500 additional units to companies in other countries over the next four years, respectively, at a price of $345. This price is fixed. The tax rate is 30 percent, and the required return is 12 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
Answer:
1. Calculation of Present Value of Outflow required
Cost of Equipment
$4,500,000
Add: Net Working Capital Requirement
$102,000
Total Cash Outflow required
$4,602,000
2. Present Value of Cash flows from Operation
A. Contribution from Sale of Additional units in other countries
Year
1
2
3
4
Expected Sales Unit to other Countries
10200
11100
13200
10500
A.
Sales @ $345 /Unit
3519000
3829500
4554000
3622500
B.
Variable Cost @ $162 /Unit
1652400
1798200
2138400
1701000
C.
Contribution (Sales - Variable Cost)
1866600
2031300
2415600
1921500
Calculation of Present Value of Cash Inflow from Sale of Additional Units in other countries:
Year
1
2
3
4
Total
A.
Contribution from Sale to other countries
1866600
2031300
2415600
1921500
B.
Fixed Cost
$647,000
$647,000
$647,000
$647,000
C.
Depreciation
$1,125,000
$1,125,000
$1,125,000
$1,125,000
D.
Operating Profit from Sale to other countries
$94,600
$259,300
$643,600
$149,500
E.
Less: Tax @ 30%
$28,380
$77,790
$193,080
$44,850
F.
Profit After Tax (D - E)
$66,220
$181,510
$450,520
$104,650
G.
Add: Depreciation (non-cash item)
$1,125,000
$1,125,000
$1,125,000
$1,125,000
H.
Cash Inflow from Sale to other countries
$1,191,220
$1,306,510
$1,575,520
$1,229,650
I.
Sale from equipment at 4rth year (after tax)
0
0
0
$197,400
J.
Working Capital Released
$102,000
K.
Net Cash Inflow (H + I - J)
$1,191,220
$1,306,510
$1,575,520
$1,325,050
L.
Present Value Interest Factor (at 12%)
0.893
0.797
0.712
0.635
M.
Present Value of Cash Inflow (K x L)
$1,063,759
$1,041,288
$1,121,770
$841,407
$4,068,225
Let Selling Price Per Unit = P
Contribution Per Unit = Sale Price Per Unit – Variable Cost per Unit = P – 162
Annual Contribution from Sale of 4900 VR per Year = 4900 (P – 162)
Present Value of Cash Inflow from sale of additional units = $4,068,225
Add: After Tax Present Value of Contribution from Sale of VR = 4900 (P – 162) x 3.037 = 148813 (P-162)
Total Present value = $4,068,225 + 148813 (P-162) = $4,068,225 + 148813 P - $24,107,706 = $148,813 P - $20,039,481
Since the president of the company will undertake the project only if it has an NPV of $100,000
Therefore, Present Value of Cash Inflow – Present Value of Cash Outflow must equals to $100,000
$148,813 P - $20,039,481 - $4,602,000 = $100,000
$148,813 P = $24,741,481
P = $166.258
Bid price should be set for the contract is $166.258 Per Unit of VR
Cost of Equipment
$4,500,000
Add: Net Working Capital Requirement
$102,000
Total Cash Outflow required
$4,602,000
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