Consider a project to supply Detroit with 40,000 tons of machine screws annually
ID: 2651573 • Letter: C
Question
Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,400,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $850,000 and that variable costs should be $450 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $380,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $560 per ton. The engineering department estimates you will need an initial net working capital investment of $540,000. You require a 12 percent return and face a marginal tax rate of 38 percent on this project.
Suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. What is the sensitivity of the project OCF to changes in the quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
What is the sensitivity of NPV to changes in quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Given the sensitivity number you calculated, what is the minimum level of output below which you wouldn’t want to operate? (Do not round intermediate calculations and round your final answer to the nearest whole number.)
Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,400,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $850,000 and that variable costs should be $450 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $380,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $560 per ton. The engineering department estimates you will need an initial net working capital investment of $540,000. You require a 12 percent return and face a marginal tax rate of 38 percent on this project.
Explanation / Answer
the Initial investment = 54,00,000 so annual depreciation = $ 900,000 [54,00,000/6]
calculation of operating cash flow:
earning before tax = Quantity sold(selling price-variable cost) -fixed cost -depreciation
40000(560-450 )- 850,000 - 900,000**
4,400,000- 850,000 - 900,000
= 2,650,000
Earning after tax =Earning before tax(1--tax)
=2650000(1-.38)
= $ 1,643,000
operating cash flow = earning after tax + depreciation
= 1643000 +900000
= $ 2,543,000
Present value of cash flows = PVAF@12%,6years *Operating cash flow +PVF@12%,6years *additional cash flow at year5)
= (4.1114*2543000) +(.50663*775600)
= 10461902+392942.23
=10,854,844.23
**salvage value net of capital gain tax = 380000 (1-.38 )= 235,600
working capital = 540000
Total additional cash flow at year 5 = (235600+540000)=775,600
so NPV=Present value of cash flow -Initial investment
= 10,854,844.23 -(5400000+540000)
= $ 4,914,844.23
Now suppose if quantity falls to 35000 tons
operating cash flow =[35000(560-450) -850000-900,000)(1-.38)]
= [(3850000-1750000)(.62)]
= 1,302,000 + 900,000 = 2,202,000
present value of cash flow = (4.1114*2202000)+(.50663*775600)
= 9053302.8+392942.23
=9,446,245.03
NPV= 9445245.03 -(5400000+540000)
= 3,506,245.03
case a) change in OCF/Change in quantity = (2543000-2202000)/(40000-35000)
=341,000/5000
=68.20
case b)change in NPV /Change in quantity = (4914844.23-3506245.03)/(40000-35000)
=1408599.2/5000
=281.72
case c)total fixed cost /contribution per uunit
(850000+900000)/(560-450)
1750000/110
15909.09 tons
any ton below it you will not operate.
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