Consider a project to supply 109 million postage stamps per year to the U.S. Pos

Question

Consider a project to supply 109 million postage stamps per year to the U.S. Postal Service for the next five years. You have an idle parcel of land available that cost $1,990,000 five years ago; if the land were sold today, it would net you $2,190,000 aftertax. The land can be sold for $2,390,000 after taxes in five years. You will need to install $5.49 million in new manufacturing plant and equipment to actually produce the stamps; this plant and equipment will be depreciated straight-line to zero over the project’s five-year life. The equipment can be sold for $590,000 at the end of the project. You will also need $690,000 in initial net working capital for the project, and an additional investment of $59,000 in every year thereafter. Your production costs are .59 cents per stamp, and you have fixed costs of $1,030,000 per year. If your tax rate is 34 percent and your required return on this project is 12 percent, what bid price should you submit on the contract? (Do not round intermediate calculations and round your answer to 5 decimal places, e.g., 32.16161.)

Explanation / Answer

Cash Outflow in Year 0 = Purchase Price of Plant + Initial Working Capital = 5490000+690000 = $6180000

Cost per year = Production Cost + Fixed Cost + Working Capital

= (0.59*109000000)+1030000 = $65340000

Cost per year (Net of Tax) = 65340000(1-0.34) = $43124400

Let Bid Price = $X

Saving =            109000000X(1-0.34) - 43124400 = 71940000X- 43124400

Sacrp Value on Sale of Land(Net of Tax)

Sale Value                               2390000

Less: Cost                                1990000

Profit on Sale                           400000

Tax = 400000*0.34 = 136000

Sale Net of Tax = 2390000-136000

Cash Outflows = Cash Inflows

6392695          = 259343700X - 160495170

X = 0.64350

Therefore, Bid Price should be $0.64350

Particulars Period PVF Amount Initial Investment 6180000 1 -6180000 Working Capital per year 59000 3.605 -212695 Total Outflows -6392695 Saving per year 71940000X- 43124400 3.605 259343700X-155463462 Scrap Value (Net of Tax) 389400 0.567 220790 Tax Saving on Dep 980000 3.605 3532900

Sacrp Value on Sale of Land(Net of Tax)

Sale Value                               2390000

Less: Cost                                1990000

Profit on Sale                           400000

Tax = 400000*0.34 = 136000

Sale Net of Tax = 2390000-136000

2254000 0.567 1278018 Total Cash Inflows 259343700X - 160495170

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