You have the opportunity to bid on a project to provide the U.S. government with

Question

You have the opportunity to bid on a project to provide the U.S. government with 2,500 whatchamacallits per year for five years. You have decided for the project to be worthwhile you will need to earn a 15% annual return. To make the whatchamacallits, you will have to increase inventory by $50,000 and purchase new equipment for $475,000 which will be depreciated on a straight-line basis. At the conclusion of the project, the machinery will have a value of $50,000. Each year, you estimate that production will cost you $17.50 per whatchamacallit. If your tax rate is 40%, what price do you need to set per whatchamacallit?

Explanation / Answer

Therefore the price should be $89.35 to get a return of 15%.

Check:

-22

NPV is almost zero.

The Project can be accepted if the NPV is atleast = 0. ie: 0 = [(2500*x)-(2500*17.5)]*0.6 *pvifa(15,5)+ 85000*0.4*pvifa(15,5)+100000*pvif(15,5) - 525000 where x = Price to be set. 0 = [(2500*x)-43750]*0.6 *3.3522+ 85000*0.4*3.3522+100000*0.4972 - 525000 0 = 5028.3x - 87995.25 + 113974.8 + 49720 - 525000 5028.3x = 449300.45 x = 449300.45/5028.3 = 89.35

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