Consider a project to supply 105 million postage stamps per year to the U.S. Pos
ID: 2779817 • Letter: C
Question
Consider a project to supply 105 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 $1,950,000 five years ago; if the land were sold today, it would net you $2,150,000 aftertax. The land can be sold for $2,350,000 after taxes in five years. You will need to install $5.45 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 $550,000 at the end of the project. You will also need $650,000 in initial net working capital for the project, and an additional investment of $55,000 in every year thereafter. Your production costs are .55 cents per stamp, and you have fixed costs of $1,090,000 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 answer to 5 decimal places, e.g., 32.16161.)
Bid price = ?
Explanation / Answer
Loss of proceeds from Sale of land now = Loss of proceeds - capital gain on sale
-2150000+(2150000-1950000)*30%
Proceeds from sale of land later = 2350000-(2350000-1950000)*30%
Year 5 working capital =Recovery of working capital - 55000 = 650000-55000 = $595000
Annual depreciation = 545000/5 = 1090000
Tax saving on depreciation = 30%*1090000 = 327000
Annual costs = (Production cost+ Fixed cost)*(1-tax) -Tax on depreciation
= (0.55*105,000,000 + 1090,000)*70% - 327000
= 40,861,000
The total cash flows are presented in the table below:
The bid price = NPV of the cash flows discounted at 10%.
Using the excel NPV built in function,
Bid price should be at least $161,266,523.34 (=NPV(10%, cash flows from years 1-5))+Cash flows in year 0)
Year Loss of proceeds from Sale of land now Proceeds from sale of land later Initial equipment Operating cash flows as per workings Sale of equipment post tax Working capital Net cash flows 0 -2090000 -5450000 -650000 -8190000 1 -40861000 -55000 -40916000 2 -40861000 -55000 -40916000 3 -40861000 -55000 -40916000 4 -40861000 -55000 -40916000 5 2230000 -40861000 385000 595000 -37651000Related Questions
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