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In: Finance

Consider a project to supply 100 million postage stamps per year to the U.S. Postal Service...

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?

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Expert Solution

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


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