Consider a project to supply 102 million postage stamps per year to the U.S. Pos

Question

Consider a project to supply 102 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 $1,920,000 five years ago; if the land were sold today, it would net you $2,120,000 aftertax. The land can be sold for $2,320,000 after taxes in five years. You will need to install $5.42 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 projects five-year life. The equipment can be sold for $520,000 at the end of the project. You will also need $620,000 in initial net working capital for the project, and an additional investment of $52,000 in every year thereafter. Your production costs are 0.52 cents per stamp, and you have fixed costs of $1,070,000 per year. If your tax rate is 30 percent and your required return on this project is 10 percent, what bid price should you submit on the contract? (Do not round intermediate calculations and round your final answer to 5 decimal places. (e.g., 32.16161))

Explanation / Answer

From the data provided we construct following tables:

The bid price should be that price where cash in- flow for all the 5 years discounted at 10% p.a. should be equal to initial cash outflow. Now cash inflow each year is fixed as per bid price. We assume that total sales revenue of all stamps is $ X per annum.

Initial Cash outflow = $816000 (as per table 1 above)

Present value of gains from land and Plant &Machinery at the end of 5 years = $447063.35260 (as per table 2 above)

Hence net Initial Cash outflow = $816000 - $447063.35260 = $ 7712936.64740

This should be equal to cash in-flow discounted at 10% for next 5 years.

From table 4 , Cash in-flow per year = $ 0.7*(X-1652400) = 0.7X - 1156680

This revenue per annum is fixed for all 5 years hence discounted at 10% this should be equal to $ 7712936.64740

or say, (0.7X - 1156680 ) / 1.1 + (0.7X - 1156680 ) / 1.12 + (0.7X - 1156680 ) / 1.13 + (0.7X - 1156680 ) / 1.14 +(0.7X - 1156680 ) / 1.15 = $7712936.64740

or say, 0.7X - 1156680 * [(1/1.1)+(1/1.21)+ (1/1.331) + (1/1.4641)+(1/1.61051)] =  $7712936.64740

or say, 0.7X - 1156680 * (3.790867694) = $7712936.64740

or say 2.6535507386X - 4384727.24043936 =  $7712936.64740

or say 2.6535507386X = (7712936.64740 + 4384727.24043936)

or say 2.6535507386X = 12097663.88784

X = $4559047.51014

Hence total sales per annum should be $4559047.51014 from the sales of 102 million stamps.

Hence bid price for each stamp = 4559047.51014 /102000000 = $0.0446965 or say 4.46965 cents per stamp.

Table -1 Initial Cash outflow Land cost 2120000 Plant & Machinery cost 5420000 Initial working capital 620000 Total 8160000   

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