Consider a project to supply 104 million postage stamps per year to the U.S. Pos
ID: 2791709 • Letter: C
Question
Consider a project to supply 104 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 $1,940,000 five years ago; if the land were sold today, it would net you $2,140,000 aftertax. The land can be sold for $2,340,000 after taxes in five years. You will need to install $5.44 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 $540,000 at the end of the project. You will also need $640,000 in initial net working capital for the project, and an additional investment of $54,000 in every year thereafter. Your production costs are .54 cents per stamp, and you have fixed costs of $1,090,000 per year. If your tax rate is 35 percent and your required return on this project is 11 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.)
Consider a project to supply 104 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 $1,940,000 five years ago; if the land were sold today, it would net you $2,140,000 aftertax. The land can be sold for $2,340,000 after taxes in five years. You will need to install $5.44 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 $540,000 at the end of the project. You will also need $640,000 in initial net working capital for the project, and an additional investment of $54,000 in every year thereafter. Your production costs are .54 cents per stamp, and you have fixed costs of $1,090,000 per year. If your tax rate is 35 percent and your required return on this project is 11 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
(a) Year 0 1 -5 5 Cost of equipment -5440000 Net Working capital -640000 -54000 73000 opportunity cost of land -2140000 2340000 Revanue (Units sold X SP. P.u.) B x 104000000 Less : Variable cost (VCp.u X Units) 56160000 Less : Fixed Cost + Depreciation (1090000+1088000) 2178000 EBIT 104000000B-5616000-2178000 Less: Tax @ 35% (104000000B-5616000-2178000) x 0.35 Net Income (104000000B-5616000-2178000) x 0.65 Add: Depreciation 1088000 CFAT [(104000000B-5616000-2178000) x 0.65] + 1088000 Post tax Salvage value (540000 x (1-0.35)) 351000 Cash flows -8220000 [(104000000B-5616000-2178000) x 0.65] + 1088000 2764000 PV Factors @ 11% 1 3.6959 0.593451328 Present value of cash flows -8220000 1640299.471 NPV = sum of PV of Cashflows Depreciation = 5440000/5 = 1088000 Minimum Bid should be such that it will make the NPV 0 at discount rate of 11% NPV = Sum of PV of cash flows i.e. -8220000+1640299 + operating cash flows = 0 Operating cash flows = 6579700.529 Annual OCF = PV/ Annuity factor = 6579701/3.6959 = 1780271.609 Let Bid price be B [(104000000 B - 56160000 -2178000) X (1-0.35)] + 1088000 =1780271 104000000 B -56160000 - 2178000 = (1780271 - 1088000)/0.65 104000000 B =1065033 + 58338000 B = 59403033/104000000 = 0.57118301 Please provide feedback… Thanks in Advance :-)
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