Question
In: Finance
Consider a project to supply 90 million postage stamps per year to the U.S. Postal Service...
Consider a project to supply 90 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 $1,655,000 five years ago; if the land were sold today, it would net you $1,730,000 aftertax. The land can be sold for $1,738,000 after taxes in five years. You will need to install $4.85 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 $475,000 at the end of the project. You will also need $525,000 in initial net working capital for the project, and an additional investment of $40,000 in every year thereafter. Your production costs are .38 cents per stamp, and you have fixed costs of $950,000 per year. If your tax rate is 21 percent and your required return on this project is 8 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.)
What bid price should you submit on the contract?
Solutions
Expert Solution
| Tax rate | 21% | ||||||
| Calculation of annual depreciation | |||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Total | |
| Cost | $ 4,850,000 | $ 4,850,000 | $ 4,850,000 | $ 4,850,000 | $ 4,850,000 | ||
| Dep Rate | 20.00% | 20.00% | 20.00% | 20.00% | 20.00% | ||
| Depreciation | Cost * Dep rate | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | $ 4,850,000 |
| Calculation of after-tax salvage value | |||||||
| Cost of machine | $ 4,850,000 | ||||||
| Depreciation | $ 4,850,000 | ||||||
| WDV | Cost less accumulated depreciation | $ - | |||||
| Sale price | $ 475,000 | ||||||
| Profit/(Loss) | Sale price less WDV | $ 475,000 | |||||
| Tax | Profit/(Loss)*tax rate | $ 99,750 | |||||
| Sale price after-tax | Sale price less tax | $ 375,250 | |||||
| Calculation of annual operating cash flow | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |||
| No of units | 90,000,000 | 90,000,000 | 90,000,000 | 90,000,000 | 90,000,000 | ||
| Selling price | $ - | $ - | $ - | $ - | $ - | ||
| Operating cost | $ 0.38 | $ 0.38 | $ 0.38 | $ 0.38 | $ 0.38 | ||
| Sale | $ - | $ - | $ - | $ - | $ - | ||
| Less: Operating Cost | $ 34,200,000 | $ 34,200,000 | $ 34,200,000 | $ 34,200,000 | $ 34,200,000 | ||
| Contribution | $(34,200,000) | $(34,200,000) | $(34,200,000) | $ (34,200,000) | $(34,200,000) | ||
| Less: Marketting cost | $ 950,000 | $ 950,000 | $ 950,000 | $ 950,000 | $ 950,000 | ||
| Less: Depreciation | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | ||
| Profit before tax (PBT) | $(36,120,000) | $(36,120,000) | $(36,120,000) | $ (36,120,000) | $(36,120,000) | ||
| Tax@21% | PBT*Tax rate | $ (7,585,200) | $ (7,585,200) | $ (7,585,200) | $ (7,585,200) | $ (7,585,200) | |
| Profit After Tax (PAT) | PBT - Tax | $(28,534,800) | $(28,534,800) | $(28,534,800) | $ (28,534,800) | $(28,534,800) | |
| Add Depreciation | PAT + Dep | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | $ 970,000 | |
| Cash Profit after-tax | $(27,564,800) | $(27,564,800) | $(27,564,800) | $ (27,564,800) | $(27,564,800) | ||
| Calculation of NPV | |||||||
| 8.00% | |||||||
| Year | Land | Capital | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values |
| 0 | $ (1,730,000) | $ (4,850,000) | $ (525,000) | $ (7,105,000) | 1.0000 | $ (7,105,000) | |
| 1 | $ (40,000) | $(27,564,800) | $ (27,604,800) | 0.9259 | $ (25,560,000) | ||
| 2 | $ (40,000) | $(27,564,800) | $ (27,604,800) | 0.8573 | $ (23,666,667) | ||
| 3 | $ (40,000) | $(27,564,800) | $ (27,604,800) | 0.7938 | $ (21,913,580) | ||
| 4 | $ (40,000) | $(27,564,800) | $ (27,604,800) | 0.7350 | $ (20,290,352) | ||
| 5 | $ 1,738,000 | $ 375,250 | $ 685,000 | $(27,564,800) | $ (24,766,550) | 0.6806 | $ (16,855,698) |
| Net Present Value | $(115,391,297) | ||||||
| Now assumed per stamp bid price | P | ||||||
| Sum of PV factor for year 1-5 | 3.9927 | ||||||
| After tax revenue for year1-5 | P*(1-21%)*3.9927*90000000 | ||||||
| P*(1-21%)*3.9927*90000000= | $ 115,391,297 | ||||||
| 283880970*P= | 115391296.8 |
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