Question

Consider a project to supply 100 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 $750,000 five years ago; if the land were sold today, it would net you $1,125,000 aftertax. The land can be sold for $1,295,000 after taxes in five years. You will need to install $5.1 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 $450,000 at the end of the project. You will also need $425,000 in initial net working capital for the project, and an additional investment of $50,000 in every year thereafter. Your production costs are .38 cents per stamp, and you have fixed costs $1.1 million per year. If your tax rate is 23 percent and your required return on this project is 10 percent, what bid price should you submit on the contract?

Answer 1

The bid price that should be submitted on the contract based on the information given about the project will be $0.030257.

How to calculate the bid?

Firstly, we simply need to calculate the annual depreciation. This will be:

= Investment - Salvage value / Useful life

= 5100000/5

= $1,020,000

Let's assume that the bid price is x, the operating cash flow will be:

= [Revenue - Variable cost - Fixed cost - Depreciation) × (1 - tax rate)

= (1000000000x - 380000 × -1100000 - 1020000) × (1 - 23%) + 1020000

= 77000000x - 1925000 + 1020000

= 77000000x - 905000

The bid price will now be:

NPV = Present value of investment + Present value of operating cash flow

0 = -5401174.1 + (77000000x - 905000) × PVIFA(10%, 5 years)

0 = -5401174.1 + (77000000x - 905000) × 3.79

77000000x = (5401175.09/3.79) + 945000

x = 2329816.38/77000000

= 0.03257

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