Consider a project to supply Detroit with 40,000 tons of machine screws annually

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

1. Operating cash flow

Operating cash flow = (selling price per unit minus variable cost per unit)* qty supplied - fixed cost)(1-tax rate)+ Depreciaton (1- tax rate)

={(560-450)*40000-850000}*(1-38%)+900000*(1-38%)

=$2759000

if the qty supplie would be changed to 35000 than the operating cash flow would be as follows

={(560-450)*40000-850000}*(1-38%)+900000*(1-38%)

=$2418000

so the changes in operating cash flow = $2759000-$2418000

=$341000

Changes in qty supplied= 40000-35000

=5000

so the changes in the OCF and qty supplied would be =341000/5000

=$68.2 per unit

2.

Particular Amount Actual Qty supply 40000 tonnes Selling price 560 per ton Variable cost 450 per ton fixed cost 850000 Depreciation (5400000/6) 900000

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