Consider a project to supply Detroit with 40,000 tons of machine screws annually
ID: 2651607 • 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 $540,000. You require a 12 percent return and face a marginal tax rate of 38 percent on this project.
Explanation / Answer
WN-1 Calculation of Base case OCF
Particulars
Amount ($) (Csae -1)
Amounts (Case-2)
Quantity
40,000 tons
41000 tons
Sales @ $ 560 per ton
224,00,000
229,60,000
Variable cost @ $ 450 per ton
180,00,000
184,50,000
Annual Fixed Cost
850,000
850,000
Annual Depreciation (850000/6)
141,666.67
Salvage value after tax ( 380,000 x 0.62)
235,600
OCF=( Sales – cost ) x (1- Tax rate) + Depreciation x Tax rate
OCF= ( 224,00,00- 180,00,000-850,000) (1-0.38) + 141666.67 x 0.38
OCF= 22,01,000 + 53,833.33
OCF= 22,54,833
WN-2 Calculation of Base Case NPV
NPV= Present Value of future cash inflows- Present value of cash outflow
PV ( Future cash Inflow)
= PV of Annual OCF + PV of Salvage value + PV of release of working capital
=( 22,54,833 x 4.1114 ) + ( 0.5066 x 235600) + ( 0.5066 x 540,000)
= 9,663,439
PV ( Cash Outflow)
= Initial Investment + Investment in working capital
= 5400,000+ 540,000
= 59,40,000
NPV= $ 37,23,439
(‘a) Sensitivity of the project OCF to change in quantity supplied
Let’s assume quantity is 41,000 tons
Then OCF will be 23,33,033
Hence change in OCF per unit of change in volume
=( 23,33,033- 22,54,833 )/ (41000-40000)
= 68200/1000
= $ 68.20 ( it means OCF will be increased by $ 68.20 when volume increased by 1 unit)
(‘b)
NPV at 41,000 tons
NPV= (2333033 x 4.1114 )+ (0.5066 x 235600) + (0.5066 x 540000) -59,40,000
NPV= 9943838-5940000
NPV= 40,03,838
Hence change in NPV per unit of change in volume
= (4003838- 3723439)/ (41000-40000)
= $ 280.40 ( It means NPV will be increased by $ 280.40 when volume increased by 1 unit )
Particulars
Amount ($) (Csae -1)
Amounts (Case-2)
Quantity
40,000 tons
41000 tons
Sales @ $ 560 per ton
224,00,000
229,60,000
Variable cost @ $ 450 per ton
180,00,000
184,50,000
Annual Fixed Cost
850,000
850,000
Annual Depreciation (850000/6)
141,666.67
Salvage value after tax ( 380,000 x 0.62)
235,600
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