Question
In: Finance
Consider a project to supply 70 million postage stamps annually for the next five years. You...
Consider a project to supply 70 million postage stamps annually for the next five years. You have an idle parcel of land available that cost $279,000 five years ago; if the land were sold today, it would net you $310,000, aftertax. You estimate the land can be sold for $400,000 after taxes in five years. You will need to install $1,867,000 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. Ignore bonus depreciation. The equipment can be sold for $950,000 at the end of the project. You will also need $32,000 in initial net working capital for the project, and an additional investment of $5,000 every year starting with Year 1. All net working capital will be recovered when the project ends. Your production costs are .21 cents per stamp, and you have fixed costs of $440,000 per year. Assume the tax rates are suddenly increased such that a tax rate of 35 percent is once again applicable, and your required return on this project is 14 percent. What bid price per stamp should you submit?
MUST be one of these answers:
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$.02264 |
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$.01619 |
||
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$.02192 |
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$.01667 |
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$.01992 |
Solutions
Expert Solution
| Tax rate | 35% | ||||||
| Calculation of annual depreciation | |||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Total | |
| Cost | $ 1,867,000 | $ 1,867,000 | $ 1,867,000 | $ 1,867,000 | $ 1,867,000 | ||
| Dep Rate | 20.00% | 20.00% | 20.00% | 20.00% | 20.00% | ||
| Depreciation | Cost * Dep rate | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | $ 1,867,000 |
| Calculation of after-tax salvage value | |||||||
| Cost of machine | $ 1,867,000 | ||||||
| Depreciation | $ 1,867,000 | ||||||
| WDV | Cost less accumulated depreciation | $ - | |||||
| Sale price | $ 950,000 | ||||||
| Profit/(Loss) | Sale price less WDV | $ 950,000 | |||||
| Tax | Profit/(Loss)*tax rate | $ 332,500 | |||||
| Sale price after-tax | Sale price less tax | $ 617,500 | |||||
| Calculation of annual operating cash flow | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |||
| No of units | 70,000,000 | 70,000,000 | 70,000,000 | 70,000,000 | 70,000,000 | ||
| Selling price | $ - | $ - | $ - | $ - | $ - | ||
| Operating cost | $ 0.21 | $ 0.21 | $ 0.21 | $ 0.21 | $ 0.21 | ||
| Sale | $ - | $ - | $ - | $ - | $ - | ||
| Less: Operating Cost | $ 14,700,000 | $ 14,700,000 | $ 14,700,000 | $ 14,700,000 | $ 14,700,000 | ||
| Contribution | $(14,700,000) | $(14,700,000) | $(14,700,000) | $(14,700,000) | $(14,700,000) | ||
| Less: Fixed cost | $ 440,000 | $ 440,000 | $ 440,000 | $ 440,000 | $ 440,000 | ||
| Less: Depreciation | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | ||
| Profit before tax (PBT) | $(15,513,400) | $(15,513,400) | $(15,513,400) | $(15,513,400) | $(15,513,400) | ||
| Tax@35% | PBT*Tax rate | $ (5,429,690) | $ (5,429,690) | $ (5,429,690) | $ (5,429,690) | $ (5,429,690) | |
| Profit After Tax (PAT) | PBT - Tax | $(10,083,710) | $(10,083,710) | $(10,083,710) | $(10,083,710) | $(10,083,710) | |
| Add Depreciation | PAT + Dep | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | $ 373,400 | |
| Cash Profit after-tax | $ (9,710,310) | $ (9,710,310) | $ (9,710,310) | $ (9,710,310) | $ (9,710,310) | ||
| Calculation of NPV | |||||||
| 14.00% | |||||||
| Year | Land | Capital | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values |
| 0 | $ (310,000) | $ (1,867,000) | $ (32,000) | $ (2,209,000) | 1.0000 | $ (2,209,000) | |
| 1 | $ (5,000) | $ (9,710,310) | $ (9,715,310) | 0.8772 | $ (8,522,202) | ||
| 2 | $ (5,000) | $ (9,710,310) | $ (9,715,310) | 0.7695 | $ (7,475,616) | ||
| 3 | $ (5,000) | $ (9,710,310) | $ (9,715,310) | 0.6750 | $ (6,557,558) | ||
| 4 | $ (5,000) | $ (9,710,310) | $ (9,715,310) | 0.5921 | $ (5,752,243) | ||
| 5 | $ 400,000 | $ 617,500 | $ 52,000 | $ (9,710,310) | $ (8,640,810) | 0.5194 | $ (4,487,766) |
| Net Present Value | $(35,004,384) | ||||||
| After tax revenue for 70000000 | 70000000*P*(1-35%) | ||||||
| Sum of PV factor for years 1-5 | 3.4331 | ||||||
| 70000000*P*(1-35%)*3.4331= | $ 35,004,384 | ||||||
| 156205184.08306*P= | $ 35,004,384 | ||||||
| P= | 35004384.2377057/156205184.08306 | ||||||
| P= | $ 0.2241 |
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plant and equipment. This will be depreciated straight-line to zero
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