Your company has been approached to bid on a contract to sell 4,200 voice recogn

Question

Your company has been approached to bid on a contract to sell 4,200 voice recognition (VR) computer keyboards per 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $3.8 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 $95,000 to be returned at the end of the project, and the equipment can be sold for $275,000 at the end of production. Fixed costs are $640,000 per year, and variable costs are $155 per unit. In addition to the contract, you feel your company can sell 9,500, 10,400, 12,500, and 9,800 additional units to companies in other countries over the next four years, respectively, at a price of $310. This price is fixed. The tax rate is 40 percent, and the required return is 10 percent. The bid price you plan to submit is $290 per unit.  

What is the NPV of the project?  

What is the IRR?  

How much does the NPV change if you change the bid price to $289 per unit?

Explanation / Answer

1)

where sales -cost = number of units sold*(selling price-variable cost)-fixed cost+number of units sold in other countries*(selling price in other country-variable cost)

2)

3)

Change in NPV = 438726.8-446714.8 = -7988

Time line 0 1 2 3 4 Cost of new machine -3800000 Cost of training -95000 =Initial Investment outlay -3895000 Sales-cost 1399500 1539000 1864500 1446000 -Depreciation Cost of new machine/4 -950000 -950000 -950000 -950000 =Pretax cash flows 449500 589000 914500 496000 -taxes =(Pretax cash flows)*(1-tax) 269700 353400 548700 297600 +Depreciation 950000 950000 950000 950000 =after tax operating cash flow 1219700 1303400 1498700 1247600 +Reversal of NWC 95000 +Proceeds from sale of asset =Selling price*(1-tax rate) 165000 Non operating cash flow 260000 Total Cash flow for the period -3895000 1219700 1303400 1498700 1507600 Required rate of return= 10% Discount factor= (1+ required rate)^N 1 1.1 1.21 1.331 1.4641 Discounted cash flow= total cash flow/discount factor -3895000 1108818 1077190 1125995 1029711 NPV= Sum of discounted cash flow = 446714.8

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