Your company has been approached to bid on a contract to sell 5,200 voice recogn

Question

Your company has been approached to bid on a contract to sell 5,200 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $4.8 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 $105,000 to be returned at the end of the project, and the equipment can be sold for $285,000 at the end of production. Fixed costs are $650,000 per year, and variable costs are $165 per unit. In addition to the contract, you feel your company can sell 10,500, 11,400, 13,500, and 10,800 additional units to companies in other countries over the next four years, respectively, at a price of $360. This price is fixed. The tax rate is 30 percent, and the required return is 13 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? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Particulars Year 1 Year 2 Year 3 Year 4 Sales (year 1-4) 5200x 5200x 5200x 5200x Contribution from Additional Sales Contribution = 360-165 =195 p.u 2047500 2223000 2632500 2106000 Salvage value of Plant 285000 Released working capital 105000 Total (a) 5200x + 2047500 5200x + 2223000 5200x + 2632500 5200x + 2496000 Less : Variable Cost 858000 858000 858000 858000 Fixed Cost 650000 650000 650000 650000 Depreciation 1200000 1200000 1200000 1200000 Net working capital 105000 Total (b) 2813000 2708000 2708000 2708000 Net Profit (a) - (b) 5200x -765500   5200x - 485000 5200x - 75500 5200x - 212000 Tax Rate 0.3 0.3 0.3 0.3 Net of Tax (1-0.3) 3640x -535850 3640x - 339500 3640x - 52850 3640x - 148400 PVF @ 13% 0.884955752 0.783146683 0.693050162 0.613318728 Present Value of Net profit 3221.239x - 474204 2850.654x - 265878 2522.703x - 36627.7 2232.48x - 91016.5 As Project will be accepted only if the NPV is atleast 100000 so the total profit should be equal to 100000 3221.239x - 474204+ 2850.654x - 265878+ 2522.703x - 36627.7+ 2232.48x - 91016.5 = 100000 10827.08x - 867726.04 = 100000 10827.08x = 967726.04 x = 967726.04/10827.08 x = 89.38 Minimum Selling Price should be $ 89.38

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