Setting the Bid Price Early on, we used discounted cash ow analysis to evaluate a proposed new product. A somewhat different [and very common] scenario arises when we must submit. a competitive bid to win a job. Under such circumstances, the winner is whoever subs mits the lowest bid. There is an old saw concerning this process: the low bidder is whoever makes the biggest mistake This is called the winner's curse. In other words. if you win, there is a good chance you underbid. [n this section, we look at how tn go about setting the hid price to avoid the winner's curse. The procedure we describe is useful anytime we havetn set a price on a product or service. To illustrate how to go about setting a bid price, imagine we are in the business of buying stripped-down truck platforms and then modifying them to customer spec- ications for resale. A local distributor has requested bids for 5 specially modied trucks each year forthe next fouryears, for atntal of2 trucks in all. We need to decide what price per truck to bid. The goal of our analysis is to de terrnine the lowest price we can protably charge. This maximizes our chances of be ing awarded the contract while guarding against the winner's curse. Suppose we can buy the truck platforms for $l,{l each. The facilities we need can be leased for $24, per year. The labor and material cost to do the mod- ication works out to be about $4,000 per truck. Total cost per year will tltus be $24,Dt'l + 5 X (l + 4,] = $94,. We will need to invest $603M in mw equipment. This equipment will be de preciated straightline to a zero salvage value over the four years. It will be worth about $5, at the end of that time. We will also need to invest $403M in raw ma terials inventory and other working capital items. The relevant tax rate is 39 per; cent. What price per truck. should we bid if we require a 2i] percent return on our investment? We start out by looking at the capital spending and net working capital invests ment. We have to spend $t}.l} today for new equipment The aftertart salvage value is $5, X (1 - .39] = $33511 Furthermore, we have to invest m today in working capital. We will get this back in four years. We can't determine the operating cash ow just yet because we don't know the sales price. Thus, if we draw a time line, here is what we have so far