Your company has been approached to bid on a contract to sell 3,800 voice recogn
ID: 2651924 • Letter: Y
Question
Your company has been approached to bid on a contract to sell 3,800 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.4 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 $91,000 to be returned at the end of the project, and the equipment can be sold for $271,000 at the end of production. Fixed costs are $636,000 per year, and variable costs are $151 per unit. In addition to the contract, you feel your company can sell 9,100, 10,000, 12,100, and 9,400 additional units to companies in other countries over the next four years, respectively, at a price of $290. This price is fixed. The tax rate is 35 percent, and the required return is 9 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:
Calculation of Bid Price
Year 0
Year 1
Year 2
Year 3
Year 4
Sales Revenue (3800 Units *$290)
$ 1,102,000.00
$ 1,102,000.00
$ 1,102,000.00
$ 1,102,000.00
Add: Additional Sales Contribution
$ 1,264,900.00
$ 1,390,000.00
$ 1,681,900.00
$ 1,306,600.00
9100*(290-151)
10000*(290-151)
12100*(290-151)
9400*(290-151)
Less: Variable costs (3800 Units * $151)
$ (573,800.00)
$ (573,800.00)
$ (573,800.00)
$ (573,800.00)
Less: Fixed Costs
$ (636,000.00)
$ (636,000.00)
$ (636,000.00)
$ (636,000.00)
Less :Depreciation (3400000/4)
$ (850,000.00)
$ (850,000.00)
$ (850,000.00)
$ (850,000.00)
Profit before tax
$ 307,100.00
$ 432,200.00
$ 724,100.00
$ 348,800.00
Less: Tax @35%
$ (107,485.00)
$ (151,270.00)
$ (253,435.00)
$ (122,080.00)
Profit after tax
$ 199,615.00
$ 280,930.00
$ 470,665.00
$ 226,720.00
Add: Depreciation
$ 850,000.00
$ 850,000.00
$ 850,000.00
$ 850,000.00
Cash flows after tax
$ 1,049,615.00
$ 1,130,930.00
$ 1,320,665.00
$ 1,076,720.00
Initial Cost of equipment
$ (3,400,000.00)
Net working capital
$ (91,000.00)
$ 91,000.00
Salvage value of Equipment (Net of tax) = 271000*(1-0.35)
$ 176,150.00
Net cash flows
$ (3,491,000.00)
$ 1,049,615.00
$ 1,130,930.00
$ 1,320,665.00
$ 1,343,870.00
PVF (9%)
1.00000
0.91743
0.84168
0.77218
0.70843
1/(1+0.09)^0
1/(1+0.09)^1
1/(1+0.09)^2
1/(1+0.09)^3
1/(1+0.09)^4
PV = Net Cash Flows * PVF
$ (3,491,000.00)
$ 962,949.54
$ 951,881.15
$ 1,019,795.70
$ 952,031.39
Net Present value
$ 395,657.78
Less: Required NPV
$ (100,000.00)
Contract Bid Price Should be =
$ 295,657.78
Calculation of Bid Price
Year 0
Year 1
Year 2
Year 3
Year 4
Sales Revenue (3800 Units *$290)
$ 1,102,000.00
$ 1,102,000.00
$ 1,102,000.00
$ 1,102,000.00
Add: Additional Sales Contribution
$ 1,264,900.00
$ 1,390,000.00
$ 1,681,900.00
$ 1,306,600.00
9100*(290-151)
10000*(290-151)
12100*(290-151)
9400*(290-151)
Less: Variable costs (3800 Units * $151)
$ (573,800.00)
$ (573,800.00)
$ (573,800.00)
$ (573,800.00)
Less: Fixed Costs
$ (636,000.00)
$ (636,000.00)
$ (636,000.00)
$ (636,000.00)
Less :Depreciation (3400000/4)
$ (850,000.00)
$ (850,000.00)
$ (850,000.00)
$ (850,000.00)
Profit before tax
$ 307,100.00
$ 432,200.00
$ 724,100.00
$ 348,800.00
Less: Tax @35%
$ (107,485.00)
$ (151,270.00)
$ (253,435.00)
$ (122,080.00)
Profit after tax
$ 199,615.00
$ 280,930.00
$ 470,665.00
$ 226,720.00
Add: Depreciation
$ 850,000.00
$ 850,000.00
$ 850,000.00
$ 850,000.00
Cash flows after tax
$ 1,049,615.00
$ 1,130,930.00
$ 1,320,665.00
$ 1,076,720.00
Initial Cost of equipment
$ (3,400,000.00)
Net working capital
$ (91,000.00)
$ 91,000.00
Salvage value of Equipment (Net of tax) = 271000*(1-0.35)
$ 176,150.00
Net cash flows
$ (3,491,000.00)
$ 1,049,615.00
$ 1,130,930.00
$ 1,320,665.00
$ 1,343,870.00
PVF (9%)
1.00000
0.91743
0.84168
0.77218
0.70843
1/(1+0.09)^0
1/(1+0.09)^1
1/(1+0.09)^2
1/(1+0.09)^3
1/(1+0.09)^4
PV = Net Cash Flows * PVF
$ (3,491,000.00)
$ 962,949.54
$ 951,881.15
$ 1,019,795.70
$ 952,031.39
Net Present value
$ 395,657.78
Less: Required NPV
$ (100,000.00)
Contract Bid Price Should be =
$ 295,657.78
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