Consider a project to supply Detroit with 20,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,400,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $180 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $620,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $300 per ton. The engineering department estimates you will need an initial net working capital investment of $340,000. You require a 11 percent return and face a marginal tax rate of 38 percent on this project.

  

What is the estimated OCF for this project?

  

  

What is the estimated NPV for this project? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Suppose you believe that the accounting department

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,400,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $180 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $620,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $300 per ton. The engineering department estimates you will need an initial net working capital investment of $340,000. You require a 11 percent return and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

Please note that I have assumed that working capital is recoverable at the end of 4 years and done the calculations on that basis only. Also I have assumed 38% tax rate on salvage value of assets also.

Answer a1: OCF of project is $ 5260000. I have assumed that working capital is realised at the end of project hence not considered for OCF. Calculation explained below:

Answer a-2: NPV is $ 816900.20 as calculated below:

816900.80

Answer b:

1. Worst case:

operating cash for 1 year will be:

991450

So NPV will be: -740679.50 as shown below:

-740679.50

Answer b2: Best case

OCF for 1 year will be:

And Best case NPV will be $ 2374481.10 as shown below:

Year Sales Variable cost Fixed cost Depreciation PBT Tax PAT Operating Cash flow (PAT + Depreciation) 1 6000000 -3600000 -800000 -850000 750000 -285000 465000 1315000 2 6000000 -3600000 -800000 -850000 750000 -285000 465000 1315000 3 6000000 -3600000 -800000 -850000 750000 -285000 465000 1315000 4 6000000 -3600000 -800000 -850000 750000 -285000 465000 1315000 Operating cash flow 5260000

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