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? Please show step by step calculation. How do we get the sales/revenue value in order to be able to solve the rest of the problem?

Answer 1

Operating cash flow (OCF) each year = income after tax + depreciation - working capital investment

In year 5, the entire working capital investment is recovered, and hence the investment in working capital is negative

profit on sale of equipment at end of year 5 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of equipment   

First, we assume the bid price to be $0.01

NPV is calculated using NPV function in Excel

NPV at $0.01 bid price per stamp is -$4,261,302

The project will only be accepted if the NPV is positive.

We use GoalSeek function in Excel to find the bid price per stamp at which NPV becomes zero. This is the minimum bid price for the contract, as the project will not be accepted below this price.

The bid price per stamp is $0.0279

At this bid price, the NPV is zero. This is the minimum bid price to submit on the contract

At this bid price, the NPV is zero. This is the minimum bid price to submit on the contract