Introduction to Finance

Is the Project Benefi cial to Shareholders?
Table LE17.6
summarizes the incremental 
cash fl ows: the net initial outlay, the after-tax operating cash fl ows, and the salvage value. 
Assuming a 10 percent minimum required rate of return, the NPV is –$3,401. The com-
puter replacement project is unacceptable because the negative NPV indicates that the project 
would decrease shareholder wealth by $3,401.
Setting a Bid Price 
Often a corporation or government that needs a fi xed asset or service will solicit bids for its 
manufacture. The fi rm’s request for proposals (RFPs) will list the desired attributes and spe-
cifi cations of the item. Firms will respond to the RFP with the hope of winning the solicitor’s 
approval by verifying that it can produce the item at the lowest cost. The fi rm that makes the 
lowest bid will most likely win the contract.
Before placing a bid in response to an RFP, a fi rm’s fi nancial analysts must determine the 
price that will allow the fi rm to cover its costs and earn a suffi
cient return so its sharehold-
ers are not harmed. Put another way, the bidding fi rm must determine the minimum price at 
which the project will have a zero net present value. Any bid below this price would result in 
a negative NPV and hurt the fi rm’s shareholders. To determine the minimum bid price, the 
analyst must work backward to develop cash fl ow estimates consistent with a zero NPV and 
then convert the cash fl ow estimates into a unit price.
Suppose you are the chief fi nancial offi
cer for You-go Inc., a manufacturer of high-quality 
motorized bicycles. An RFP from a large city is seeking bids for motorized bicycles for use 
by police offi
cers on patrol. Your fi rm’s motorized bicycles will require special modifi cations 
to make them suitable for police work. Among other requirements, the RFP notes that 100 
bicycles will have to be delivered each year for the next three years. Assume You-go’s required 
return on such projects is 20 percent and the fi rm’s tax rate is 40 percent.