Question

Consider a project to supply 100 million postage stamps per year to the USPS for the next five years. To pursue the project, you will need to install $4.1 million in new manufacturing plant and equipment. This will be depreciated straight-line to zero over the project’s five years. The equipment can be sold for $540,000 at the end of the project. You will also need $600,000 in initial net working capital for the project and an additional investment of $50,000 in every year thereafter. All net working capital will be recouped at the end of the project. Your production costs are $.005 per stamp and you have fixed costs of $950,000 per year. If your tax rate is 34% and your required return is 12%, what bid price should you submit on the contract?

Answer 1

	Let Bid price be		x
	Year		0	1 - 5	5
	Fixed Asset		-4100000
	Increase in NWC		-600000	-50000
	Sales			100000000 x
	Less: Cost	(0.005 x 100m)		500000
	Less Depreciation	4100000/5		820000
	Less: Fixed Cost			950000
	Earnings before tax			100000000x - 2270000
	Less; Tax @ 34%			34000000x-771800
	Earnings after tax			66000000x-1498200
	Add: Depeciation			820000
	Cash flow after tax			66000000x - 678200
	Post tax Salvage value of Asset	(540000 x (1 - 0.34))			356400
	Recovery of Working capital				350000
	Net cashflows		-4700000	66000000x - 628200	706400
	PV factors @ 12%		1	3.6048	0.567427
	Pv of Net Cash flows		-4700000	237915229x-2264520	400830.3
	Bid Price to breakeven, where NPV becomes 0
	NPV = Sum of PV of net cash flows =
	-4700000 + 237915229x -2264520 + 684543.8 =				0
	x =		6279977/237915229 =		0.028
	Bid price should be 0.028 or more to earn profit.