Consider a project to supply 118 million postage stamps per year to the U.S. Pos
ID: 2775913 • Letter: C
Question
Consider a project to supply 118 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 $2,080,000 five years ago; if the land were sold today, it would net you $2,280,000 aftertax. The land can be sold for $2,480,000 after taxes in five years. You will need to install $5.58 million 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 five-year life. The equipment can be sold for $680,000 at the end of the project. You will also need $780,000 in initial net working capital for the project, and an additional investment of $68,000 in every year thereafter. Your production costs are .68 cents per stamp, and you have fixed costs of $1,050,000 per year. If your tax rate is 34 percent and your required return on this project is 12 percent, what bid price should you submit on the contract?
Consider a project to supply 118 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 $2,080,000 five years ago; if the land were sold today, it would net you $2,280,000 aftertax. The land can be sold for $2,480,000 after taxes in five years. You will need to install $5.58 million 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 five-year life. The equipment can be sold for $680,000 at the end of the project. You will also need $780,000 in initial net working capital for the project, and an additional investment of $68,000 in every year thereafter. Your production costs are .68 cents per stamp, and you have fixed costs of $1,050,000 per year. If your tax rate is 34 percent and your required return on this project is 12 percent, what bid price should you submit on the contract?
Explanation / Answer
Evaluation of project using NPV technique 0 1 2 3 4 5 Cost of manufacturing plant 5.58 Less: Tax Saving on depreciation of plant (5.58/5)*34% -0.37944 -0.37944 -0.37944 -0.37944 -0.37944 Less:Sale value of the plant(net of tax)(0.68*(1-0.34) -0.4488 Working capital required 0.78 0.068 0.068 0.068 0.068 0.068 Production cost (117*0.0068)(1-0.34) 0.52596 0.52596 0.52596 0.52596 0.52596 Fixed Costs(1.05*(1-0.34)) 0.693 0.693 0.693 0.693 0.693 Net Costs 6.36 0.90752 0.90752 0.90752 0.90752 0.45872 PVF@12% 1 0.89285714 0.797193878 0.71178 0.635518078 0.567427 Present Value 6.36 0.81028571 0.723469388 0.645955 0.576745367 0.26029 Total Present value of net costs 9.376745326 Minimum bid price for the contract is 9.3767 million.