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
| Time line | 0 | 1 | 2 | 3 | 4 | 5 | |
| Cost of new machine | -4100000 | ||||||
| Initial working capital | -600000 | ||||||
| =Initial Investment outlay | -4700000 | ||||||
| Unit sales | 100000000 | 100000000 | 100000000 | 100000000 | 100000000 | ||
| Production cost | =no. of units sold * (- variable cost) | -500000 | -500000 | -500000 | -500000 | -500000 | |
| Fixed cost | -950000 | -950000 | -950000 | -950000 | -950000 | ||
| -Depreciation | Cost of equipment/no. of years | -820000 | -820000 | -820000 | -820000 | -820000 | |
| -working capital to be maintained | -50000 | -50000 | -50000 | -50000 | -50000 | ||
| =Pretax cash flows | -2320000 | -2320000 | -2320000 | -2320000 | -2320000 | ||
| -taxes | =(Pretax cash flows)*(1-tax) | -1531200 | -1531200 | -1531200 | -1531200 | -1531200 | |
| +Depreciation | 820000 | 820000 | 820000 | 820000 | 820000 | ||
| =after tax operating cash flow | -711200 | -711200 | -711200 | -711200 | -711200 | ||
| reversal of working capital | 850000 | ||||||
| +Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 356400 | |||||
| +Tax shield on salvage book value | =Salvage value * tax rate | 0 | |||||
| =Terminal year after tax cash flows | 1206400 | ||||||
| Total Cash flow for the period | -4700000 | -711200 | -711200 | -711200 | -711200 | 495200 | |
| Discount factor= | (1+discount rate)^corresponding period | 1 | 1.12 | 1.2544 | 1.404928 | 1.5735194 | 1.7623417 |
| Discounted CF= | Cashflow/discount factor | -4700000 | -635000 | -566964.29 | -506218.1 | -451980.5 | 280989.78 |
| NPV= | Sum of discounted CF= | -6579173.076 | |||||
Minimum bid price = 6579173.076 to cover all costs of the project
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