Advanced: Computation of a tender price using costplus pricing and an evaluation of a contract using monthly discount rates You have been appomted by Ranek pic to advise on the price that the company should tender for the construction of a small power station in a foreign country, Zmbland.

The company normally charges a price that gives a 20%

markup on all directly attributable costs (which includes leasing and the current written-down value of assets less any residual value of assets expected at the end of the contract but excludes any tax effects of such costs).
The power station will take 15 months to construct. All costs are payable in pounds sterling. Wages totalling £380 000 are payable monthly in arrears in pounds sterling. Materials are purchased two months in advance of the month when they are to be used. One month's credit is taken on all material purchases. Materials usage is expected to be £715000 per month, payable in sterling. Other direct costs are expected to be £50000 per month and the company will allocate central overhead to the project at £25 000 per month. No increases in costs are expected during the contract period.
Ranek already owns some plant and equipment that could be used in this project. These assets cost £3 million and have a written-down value of £1 .8 million after deduction of tax allowable depreciation at 25% on a reducing balance basis. If the contract is not undertaken the exisCing plant and equipment will be sold immediately for £2 million. The realizable value of these assets at the end of 15 months is expected to be £900 000. Special equipment for the contract would be obtained through an operating lease at a quarterly cost of £620000 payable in advance on the first day of the quarter.
Assume that corporate tax in the United Kingdom at the rate of 35% is payable on net cash flows six months after the end of the relevant tax year. No foreign tax liability is expected. Any tax effects associated with the disposal of assets also occur six months after the relevant year end. The end of Ranek's financial year occurs three months after the start of the project.
The tender price for the power station is to be in Zmbland dollars (Z$). Thirty per cent Is payable immediately and the balance upon completion. The current exchange rate is Z$45.5-46.0/£ and the Zmbland dollar is expected to steadily depreciate in value relative to the pound by approximately 25% during the next 15 months. No forward foreign exchange market exists.
Ranek's managers estimate that the company's opportunity cost of capital is 1% per month. The company currently has spare capacity.
Required:

(a) Estimate the tender price that would result from a 20%
markup on sterling direct costs. Ignore the time value of money in the estimate of the required markup. (5 marks)

(b) Estimate the net present value of the proposed project and discuss and recommend the minimum price that the company should tender. State clearly any assumptions that you make.