Question
In: Finance
Consider a project to supply 100 million postage stamps per year to the USPS for the...
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?
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Expert Solution
| Tax rate | 34% | ||||||
| Calculation of annual depreciation | |||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | Total | |
| Cost | $ 4,100,000 | $ 4,100,000 | $ 4,100,000 | $ 4,100,000 | $ 4,100,000 | ||
| Dep Rate (1/5=20%) | 20.00% | 20.00% | 20.00% | 20.00% | 20.00% | ||
| Depreciation | Cost * Dep rate | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | $ 4,100,000 |
| Calculation of after-tax salvage value | |||||||
| Cost of machine | $ 4,100,000 | ||||||
| Depreciation | $ 4,100,000 | ||||||
| WDV | Cost less accumulated depreciation | $ - | |||||
| Sale price | $ 540,000 | ||||||
| Profit/(Loss) | Sale price less WDV | $ 540,000 | |||||
| Tax | Profit/(Loss)*tax rate | $ 183,600 | |||||
| Sale price after-tax | Sale price less tax | $ 356,400 | |||||
| Calculation of annual operating cash flow | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |||
| No of units | 100,000,000 | 100,000,000 | 100,000,000 | 100,000,000 | 100,000,000 | ||
| Selling price | $ - | $ - | $ - | $ - | $ - | ||
| Operating ost | $ 0.005 | $ 0.005 | $ 0.005 | $ 0.005 | $ 0.005 | ||
| Sale | $ - | $ - | $ - | $ - | $ - | ||
| Less: Operating Cost | $ 500,000 | $ 500,000 | $ 500,000 | $ 500,000 | $ 500,000 | ||
| Contribution | $ (500,000) | $ (500,000) | $ (500,000) | $ (500,000) | $ (500,000) | ||
| Less: Fixed cost | $ 950,000 | $ 950,000 | $ 950,000 | $ 950,000 | $ 950,000 | ||
| Less: Depreciation | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | ||
| Profit before tax (PBT) | $ (2,270,000) | $ (2,270,000) | $ (2,270,000) | $ (2,270,000) | $ (2,270,000) | ||
| Tax@34% | PBT*Tax rate | $ (771,800) | $ (771,800) | $ (771,800) | $ (771,800) | $ (771,800) | |
| Profit After Tax (PAT) | PBT - Tax | $ (1,498,200) | $ (1,498,200) | $ (1,498,200) | $ (1,498,200) | $ (1,498,200) | |
| Add Depreciation | PAT + Dep | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | $ 820,000 | |
| Cash Profit after-tax | $ (678,200) | $ (678,200) | $ (678,200) | $ (678,200) | $ (678,200) | ||
| Calculation of NPV | |||||||
| 12.00% | |||||||
| Year | Capital | Working capital | Operating cash | Annual Cash flow | PV factor, 1/(1+r)^time | Present values | |
| 0 | $ (4,100,000) | $ (600,000) | $ (4,700,000) | 1.0000 | $ (4,700,000) | ||
| 1 | $ (50,000) | $ (678,200) | $ (728,200) | 0.8929 | $ (650,179) | ||
| 2 | $ (50,000) | $ (678,200) | $ (728,200) | 0.7972 | $ (580,517) | ||
| 3 | $ (50,000) | $ (678,200) | $ (728,200) | 0.7118 | $ (518,318) | ||
| 4 | $ (50,000) | $ (678,200) | $ (728,200) | 0.6355 | $ (462,784) | ||
| 5 | $ 356,400 | $ 800,000 | $ (678,200) | $ 478,200 | 0.5674 | $ 271,344 | |
| Net Present Value | $ (6,640,454) | ||||||
| So the present value of after tax revenue for 5 years should be $ 6,640,454 |
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