2. Hassle-Free Web is bidding to provide Web hosting services for Hotel Lisbon. Hotel Lisbon pays its current provider $10000 per year for hosting its Web page, handling transactions, etc. Hassle-Free figures that it will need to purchase equipment worth $15,000 up front and then spend $2000 per year on monitoring, updates, and bandwidth to provide the service for three years. If Hassle-Free's cost of capital is 10%, what is the minimum bid that is sustainable for Hassle-Free?
Important Hint (question is supposed to be tricky): You need to consider equivalent annual cost and compare to what is offered to make the decision.
PV of cash outflows to provide the service | ||||
interest rate | 10.00% | |||
Year | Outflow | PV fatctor | PV | |
0 | (15,000) | 1.000 | (15,000) | |
1 | (2,000) | 0.909 | (1,818) | |
2 | (2,000) | 0.826 | (1,653) | |
3 | (2,000) | 0.751 | (1,503) | |
Total | 3.487 | (19,974) | ||
with minimum bid, the PV of inflows should be atleasst 19,974 to provide 10% return | ||||
Assumed minimum bid price = P | ||||
Total of PV factor from year 1 to year 3= 2.487 | ||||
P*2.487= | 19,974 | |||
P | =19,974/2.487 | |||
P= | 8,031 | |||
So minimum sustainble bid price will be 8,031 | ||||
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