Question

Consider a project to supply 60 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 $760,000 five years ago; if the land were sold today, it would give you $912,000 after taxes. Three years ago, you purchased some equipment for $60,000. This equipment has a current book value of $40,000 and a current market value of $30,000. The land and equipment can be used for this project. You will need to install $2,356,000 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 5-year life. The equipment can be sold for $456,000 at the end of the project. You will also need $469,000 in initial net working capital for the project, and an additional investment of $38,000 in every year thereafter. All net working capital will be recovered when the project ends. Your production costs are 0.5 cents per stamp, and you have fixed costs of $608,000 per year. Your tax rate is 31 percent and your required return on this project is 11 percent. What bid price per stamp should you submit?

Answer 1

After-tax salvage value = $456,000(1 – 0.31) = $314, 640

          NPV = 0 = – $2,356,000 – $912,000 – $469,000 + OCF (PVIFA11%,5) – $38,000(PVIFA11%,4)

                                + [($314,640+ 621,000) / 1.115]

= -3,737,000+OCF (PVIFA11%,5)-117,891.2+555,256.80

          OCF = $3,299,634.4/ PVIFA11%,5 = $892,782.38

          OCF = $892,782.38 = [(P–v)Q – FC ](1 – tc) + tcD

          $892,782.38= [(P – 0.005)(60,000,000) – $608,000](1 – 0.31) + 0.31($2,356,000/5 )

    $892,782.38= [(P – 0.005)(60,000,000) – 419520 +146072

($892,782.38+419520-146072)/60,000,000 =  (P – 0.005)

P= $0.024426673