Consider a project to supply 70 million postage stamps annually for the next five years. You have an idle parcel of land available that cost $279,000 five years ago; if the land were sold today, it would net you $310,000, aftertax. You estimate the land can be sold for $400,000 after taxes in five years. You will need to install $1,867,000 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 five-year life. Ignore bonus depreciation. The equipment can be sold for $950,000 at the end of the project. You will also need $32,000 in initial net working capital for the project, and an additional investment of $5,000 every year starting with Year 1. All net working capital will be recovered when the project ends. Your production costs are .21 cents per stamp, and you have fixed costs of $440,000 per year. Assume the tax rates are suddenly increased such that a tax rate of 35 percent is once again applicable, and your required return on this project is 14 percent. What bid price per stamp should you submit?

Question

Quizplus · Accepted Answer

The correct bid price per stamp is calculated by determining the net present value (NPV) of the project to be zero, taking into account all cash inflows and outflows, including the initial investment, operating costs, depreciation, changes in net working capital, and the salvage value of the equipment and land at the end of the project. The bid price per stamp must cover all these costs and provide the required return on the project.

Consider a Project to Supply 70 Million Postage Stamps Annually