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

Solution	Calculation of minimum bid price							Amount in $
	Years	0	1	2	3	4	5	Total
	New manufacturing plant and equipment	2356000	0	0	0	0	0
	Depreciaiton tax shield [ 31%*(2356000-456000)/5]	0	-117800	-117800	-117800	-117800	-117800
	Working capital requirements	469000	0	0	0	0	0
	Additional investment every year	0	38000	38000	38000	38000	38000
	Production cost (0.5*60000000)	0	30000000	30000000	30000000	30000000	30000000
	Fixed cost		608000	608000	608000	608000	608000
	Cash outflows	2825000	30528200	30528200	30528200	30528200	30528200
	Salvage value of plant and equipment						-456000
	recovery of working capital						-469000
	Net cash outflows	2825000	30528200	30528200	30528200	30528200	29603200
	PV factor @ 11%	1	0.9009	0.8116	0.7312	0.6587	0.5935
	Present value of outflows	2825000	27502883	24777372	22321957	20109871	17568058	115105141
	Present value of outflows (A)	115105141
	Number of units to supply (B)	60000000
	Bid price per unit (A/B)	1.92	$ per unit