Question

Your company has been approached to bid on a contract to sell 5,650 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 $480,000 to be returned at the end of the project, and the equipment can be sold for $475,000 at the end of production. Fixed costs are $655,000 per year, and variable costs are $92 per unit. In addition to the contract, you feel your company can sell 14,800, 16,900, 19,600, and 12,100 additional units to companies in other countries over the next four years, respectively, at a price of $204. This price is fixed. The tax rate is 22 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 $125,000. What bid price should you set for the contract? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Bid price

Answer 1

Please find the solution in given screen shots,

Amount in $

Calculation of Bid Price Bid price for Contract Variable Cost Per Unit Required Contribution Variable Cost Per Unit 92.00 Required Contribution Per Unit = 77.22 WN 1 Bid Price Per Unit 169.22 Calcuation of Required Contribution Per Unit from the Contract WN 1 Steps: 1- Arrive at the NPV assuming there is no proposed contract 2- Find out the shortage of NPV from the NPV which is required for bidding the contract (This Shortage is nothing but the NPV from the Contribution of proposed contract) 3- Arrive at the Annuity Factor of 4 Years@discount rate of 9% 4- Divide the Shortage NPV by Annuity Factor to arrive at the post tax per year Contribution from the Contract (not in Present Value) 5-Arrive at the Pre Tax Contribution Per Unit

Step-1 NPV without the Contract Total Remarks Year 0 Year 1 Year 2 Year 3 Year 4 Equipment Working Capital Recovery of wc Net of Tax Equipment Proceed Cash from from Operation -4,800,000 -480,000 480,000 370,500 1,046,028 1,229,484 1,465,356 810,156 -5,280,000 1,046,028 1,229,484| 1,465,356|1,660,656| 0.7084 WN A WN B Net Cash Flow Discounting Factor @ 9% NPV 1.0000 0.8417 0.7722 959,659 1,034,8321,131,524 1,176,451 -977,535 0.9174 WN - C -5,280,000 Net Cash flow X Discounting Factor Step 2 Shortage of NPV NPV to be 125,000.00 NPV without Contract -977,535 Required from Contract 1,102,535 Hence NPV from after tax contribution by sale of 5650 units every year for four years 1102535 We need to arrive at contribution every year before discounting it to present value

Step 3 Annuity Factor of 4 Years @ 9% We will be using annuity factor of four years at the given discount rate which is sum of discounting factors from year 1 to year 4 Annuity Remarks Year 1 Year 2 Year 3 Year 4 Factor 0.9174 0.8417 3.2397 Sum of Year 1 to Year 4 0.7722 Discounting Factor @ 9% 0.7084 Step 4 Post Tax undiscounted contribution Per Unit Post Tax Contribution per unit NPV/Annuity Factor / 1,102,535 3.2397 340,317.98 Hence we need post tax contribution every year of 340317.98 millions from 5650 Units Per Unit Contribution 340317.98/5650 60.23 Step-5 Pre Tax undiscounted contribution Per Unit Pre Tax Contribution Post Tax Contribution/(1-Tax Rate) -60.23/(1-0.22) 77.22

Gain on Sale of Asset WN A Sale at the end of Year o fully depreciated Book Value at the end of year 4 Sale Proceed 475,000 Gain on Sale of asset Sales Proceed Net Book Value 475,000 0 475,000 Less Tax @22% 104,500 Gain Net of Tax 370,500 WN - B Cash from Operation (without the contract) Year 0 Year 3 Year 4 Year1 Year 2 Units 14800 16900 19600 12100 Sales Price Variable Cost per UNIT 204 204 204 204 92 92 92 92 Total Sales 3,019,200 3,447,600 3,998,400 2,468,400 1,361,600 1,554,8001,803,200 1,113,200| 655,000 Less: Variable Cost 655,000 655,000 1,200,000 1,200,000 1,200,000 1,200,000 655,000 Less: Fixed Cost Less Depreciation -197,400 340,200-499,800 74,844109,956 265,356-389,844 EBIT 37,800 8,316 29,484 1,200,000 1,200,000 1,200,000 1,200,000 1,046,028 1,229,484 1,465,356 Less: Tax -43,428 EAT -153,972 Add: Depreciation Operating Cash flow 810,156

Calculation of Depreciation Cost of Equipment 4,800,000 Life (Years) 4 Salvage Value 0 Depreciation (Cost - Salvage)/Life Hence 1,200,000 Discounting Factor @ 9% Discounting Factor 1/(1 r)^n where, r rate of interest and n number of year WN - C

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