1.Consider bidding for a project to supply 80 million postage stamps per year to

Question

1.Consider bidding for a project to supply 80 million postage stamps per year to USPS for the next 5 years. You have an idle parcel of land available at that cost $1 million 5 years ago, if the land was sold today, it would net you $1.2 million after tax. You will need to install $3.1 million in new manufacturing plant and equipment to produce the stamps; this equipment is considered a 5-year property for depreciation purposes which will be done according to MACRS. The equipment can be sold for $600,000 at the end of the project. You will also need $600,000 for working capital initially and $50,000 in every year thereafter. Your variable cost is half a cent for each stamp and your fixed cost is $80,000 per year. If your tax rate is 34%, and your required return is 12% and you bid $.025 for each stamp, what is your NPV? If on the other hand, you must obtain an IRR of 20% from the venture, what price will you bid for each stamp?

Explanation / Answer

All numbers are in million USD 1 2 3 4 5 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cost of land if purchased today is 1.2/(1-tax) -1.81818 No.of stamps in million 80 80 80 80 80 New manufacturing -3.1 Price per stamp in USD 0.025 0.025 0.025 0.025 0.025 Working Capital Needed -0.6 Revenue in million 2 2 2 2 2 Salvage value of plant 0.6 Variable cost 0.8 0.8 0.8 0.8 0.8 Tax Rate 34% Working Capital Needed in million -0.05 -0.05 -0.05 -0.05 -0.05 Rate of return 12% Fixed cost in million -0.08 -0.08 -0.08 -0.08 -0.08 Total Cash outflow -5.51818 Cash flow 2.67 2.67 2.67 2.67 2.67 (Salvage value of machine added) DIscounted CF @ 12% 2.383929 2.128508 1.900453 1.696833 1.51503 Post tax Cash flow 1.573393 1.404815 1.254299 1.11991 0.99992 Total Cash flow Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 -5.51818 1.573393 1.404815051 1.254299 1.11991 0.99992 NPV 0.834155 IRR 5.30% For IRR to be 20% bid price must be around 0.038per stampall else remaining constant

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