Question

Your company has been approached to bid on a contract to sell 5,250 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 Due to technological improvements, beyond that time they will be outdated and no sales will be possible.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 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 $440,000 to be returned at the end of the project, and the equipment can be sold for $395,000 at the end of production. Fixed costs are $615,000 per year, and variable costs are $84 per unit. In addition to the contract, you feel your company can sell 13,200, 15,300, 18,800, and 11,300 additional units to companies in other countries over the next four years, respectively, at a price of $188. This price is fixed. The tax rate is 24 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 $150,000. 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.)

Answer 1

Year	0	1	2	3	4
Purchase Price	$4,000,000
Investment in net Working Capital	$440,000
Sales (Domestic) (in units)		5250	5250	5250	5250
Price per unit (Domestic) (assume=x)		x	x	x	x
Sales (other contries) (in units)		13200	15300	18800	11300
Price per unit (other contries)		$188	$188	$188	$188
Revenue on Sales (Domestic)		5250x	5250x	5250x	5250x
Revenue on Sales (other contries)		$2,481,600	$2,876,400	$3,534,400	$2,124,400
Total Revenue		5250*x + $2,481,600	5250*x + $2,876,400	5250*x + $3,534,400	5250*x + $2,124,400
Variable Cost per unit		84	84	84	84
Total Variable Cost (No. of units * Variable Cost)		$1,549,800	$1,726,200	$2,020,200	$1,390,200
Fixed Cost		$615,000	$615,000	$615,000	$615,000
Total Cost		$2,164,800	$2,341,200	$2,635,200	$2,005,200
Earning before tax and Depreciation (Revenue - Total Cost)		5250*x + 316800	5250*x + 535200	5250*x + 899200	5250*x + 119200
Less Depreciation (4,000,000-395,000)/4		$901,250	$901,250	$901,250	$901,250
Earning befor tax		5250*x - 584450	5250*x - 366050	5250*x - 2050	5250*x - 782050
Earning after tax (EBT*0.76)		3990*x - 444182	3990*x - 278198	3990*x - 1558	3990 - 594358
Add Depreciation		$901,250	$901,250	$901,250	$901,250
Add Working Capital					$440,000
Add After tax salvage value (395000*0.76)					$300,200
Cash flows	-$4,440,000	3990*x + 457068	3990*x + 623052	3990*x + 899692	3990*x + 1047092
PV Factor @ 9%	1	0.9174	0.8417	0.7722	0.7084
	-$4,440,000	3660.43*x + 419314.18	3358.38*x + 524422.87	3081.08*x + 694742.16	2826.52*x + 741759.97
PV of Outflow	4444000
PV of inflow	12926.41*x + 2380239.18
NPV = 150000 =	PV of inflow - PV of outflow
	150000 = 12926.41*x + 2380239.18 - 4444000
	12926.41*x = 2213760.82
Bid Price =	x = 171.26

In the above solution depreciation has been subtracted to calculated earning before tax and then added back after calculating Earning after tax reason being depreciation is a non cash expense. Above solution can be solved without deducting the depreciation and adding depreciation tax shield after calculating earning after tax. Answer will remain same in both the solution.