Question

Consider a project to supply 100 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 $1,705,000 five years ago; if the land were sold today, it would net you $1,780,000 aftertax. The land can be sold for $1,748,000 after taxes in five years. You will need to install $5.35 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 $625,000 at the end of the project. You will also need $575,000 in initial net working capital for the project, and an additional investment of $50,000 in every year thereafter. Your production costs are .48 cents per stamp, and you have fixed costs of $1,050,000 per year. If your tax rate is 21 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.)

What is the bid price?

Answer 1

Answer: Bid Price : $ 0.50660 cents per stamp

Let the bid price be P.

Annual EBITDA = 100,000,000 * ( P - 0.48 ) - $ 1,050,000 = $ 100,000,000 P - $ 48,000,000 - $ 1,050,000 = $ 100,000,000 P - $ 49,050,000.

Annual depreciation on equipment = $ 5,350,000 / 5 = $ 1,070,000

Annual operating cash flows after taxes = $ ( 100,000,000 P - $ 49,050,000 ) x 0.79 + 1,070,000 x 0.21 = 79,000,000 P - $ 38,749,500 + $ 224,700 = 79,000,000 P - $ 38,524,800.

Cost of Equipment	$ 5,350,000
Opportunity Cost of Land	1,780,000
Working Capital Required	575,000
Total Initial Cash Outlay	$ 7,705,000

After tax salvage value of equipment = $ 625,000 x 0.79 = $ 493,750

Year	Annual Operating Cash Flows After Taxes	Working Capital Required	Working Capital Recovered	Salvage Value of Equipment	Sale Proceeds of Land	Total Cash Flows	PV Factor at 10 %	Present Values
1	79,000,000 P - 38,524,800	$ 50,000				79,000,000 P - 38,474,800	0.90909	71,818,110 P - 34,977,055.93
2	79,000,000 P - 38,524,800	50,000				79,000,000 P - 38,474,800	0.82645	65,289,550 P - 31,797,498.46
3	79,000,000 P - 38,524,800	50,000				79,000,000 P - 38,474,800	0.75131	59,353,490 P - 28,906,501.99
4	79,000,000 P - 38,524,800	50,000				79,000,000 P - 38,474,800	0.68301	53,957,790 P - 26,278,673.15
5	79,000,000 P - 38,524,800		775,000	493,750	1,748,000	79,000,000 P - 35,508,050	0.62092	49,052,680 P - 22,047,658.41
								299,471,620 P - 144,007,387.94

Minimum bid price would be at NPV = 0

or 299,471,620 P - 144,007,387.94 = 7,705,000

or P = 0.5066 or 0.51 cents