Consider a project to supply 118 million postage stamps per year to the U.S. Pos
ID: 2777231 • Letter: C
Question
Consider a project to supply 118 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 $2,080,000 five years ago; if the land were sold today, it would net you $2,280,000 aftertax. The land can be sold for $2,480,000 after taxes in five years. You will need to install $5.58 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 $680,000 at the end of the project. You will also need $780,000 in initial net working capital for the project, and an additional investment of $68,000 in every year thereafter. Your production costs are 0.68 cents per stamp, and you have fixed costs of $1,050,000 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 final answer to 5 decimal places. (e.g., 32.16161))
Consider a project to supply 118 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 $2,080,000 five years ago; if the land were sold today, it would net you $2,280,000 aftertax. The land can be sold for $2,480,000 after taxes in five years. You will need to install $5.58 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 $680,000 at the end of the project. You will also need $780,000 in initial net working capital for the project, and an additional investment of $68,000 in every year thereafter. Your production costs are 0.68 cents per stamp, and you have fixed costs of $1,050,000 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 final answer to 5 decimal places. (e.g., 32.16161))
Explanation / Answer
Solution:
We will begin by calculating the aftertax salvage value of the equipment at the end of the project’s life. The aftertax salvage value is the market value of the equipment minus any taxes paid (or refunded), so the aftertax salvage value in five years will be:
Taxes on salvage value = (BV – MV)tC
Taxes on salvage value = ($0 – 680,000)(0.34)
Taxes on salvage value = –$231,200
Market price $680,000
Tax on sale –231,200
After tax salvage value $448,800
Now we need to calculate the operating cash flow each year. Note, we assume that the net working
capital cash flow occurs immediately. Using the bottom up approach to calculating operating cash flow, we find:
Depreciation as per straight line schedule will be
Depreciation = $5.58 million / 5 = $1.116 million
Now calculate X by using NPV formula at 12% discount rate and assuming
Present value of cash inflows = present value of cash outflows
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Revenues X X X X X Fixed Cost 1050000 1050000 1050000 1050000 1050000 Variable cost(.68 of 118 million) 80240000 80240000 80240000 80240000 80240000 Depreciation 1116000 1116000 1116000 1116000 1116000 Costs 82406000 82406000 82406000 82406000 82406000 EBT X-82406000 X-82406001 X-82406002 X-82406003 X-82406004 Taxes(34%) 34%*(X-82406000) 34%*(X-82406000) 34%*(X-82406000) 34%*(X-82406000) 34%*(X-82406000) Net Income 66%*(X-82406000) 66%*(X-82406000) 66%*(X-82406000) 66%*(X-82406000) 66%*(X-82406000) OCF(NI+Dep) 66%*(X-82406000)+1116000 66%*(X-82406000)+1116000 66%*(X-82406000)+1116000 66%*(X-82406000)+1116000 66%*(X-82406000)+1116000 Capital spending -5580000 448800 Land -2280000 2480000 NWC -780000 -68000 -68000 -68000 -68000 -68000 Net Cash Flow -8640000 66%*(X-82406000)+1116000-68000 66%*(X-82406000)+1116000-68000 66%*(X-82406000)+1116000-68000 66%*(X-82406000)+1116000-68000 66%*(X-82406000)+1116000+2860800Related Questions
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