Consider a project to supply Detroit with 25,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,400,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $440,000 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 $240,000. You require a 16 percent return and face a marginal tax rate of 38 percent on 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’s initial cost and salvage value projections are accurate only to within ±15 percent; the marketing department’s price estimate is accurate only to within ±10 percent; and the engineering department’s net working capital estimate is accurate only to within ±5 percent. What is your worst-case and best-case scenario for this project? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

  

Explanation / Answer

Contribution earned on sale of one ton =$300 -$200 =$100.

Depreciation = (Cost)/ life of the asset

=($2,400,000 )/5

=$480,000.

Cash outflow in the 0 year is investment in the machine +initial working capital i.e., $2,400,000+$240,000.=$2,640,000

Cash inflow in the year 5 is cash inflow in year 5 is profit earned from operatoins net of tax+ salvage value after tax+net working capital.+depreciation

=$756,400+$440,000*62%+$240,000+$480,000

=$1,733,200

Present value of cash inflows is as follows:

NPV = Present value of cash inflows - Present value Cash outflows

= $4,284,869.62- $2,640,000

=$1,644,869.62

Answer forsubpoint b:

For costs best case would be decrease in cash outflows and for revenues best case would be increase in cash inflows, considering this the best case scenario has been calculated as below:

Revised contribution =$330 -$200 =$130.

Cash outflow in the 0 year is investment in the machine +initial working capital i.e., $2,040,000+$228,000.=$2,268,000

Cash inflow in the year 5 is cash inflow in year 5 is profit earned from operatoins net of tax+ salvage value after tax+net working capital.+depreciation

=$1,266,040+$506,000*62%+$228,000+$408,000

=$2,245,320

Present value of cash inflows is as follows:

NPV = Present value of cash inflows - Present value Cash outflows

= $5753292.39- $2,268,000

=$3,485,292.39

Worst case scenario:

For costs worst case would be increase in cash outflows and for revenues worst case would be decrease in cash inflows, considering this the worst case scenario has been calculated as below:

Contribution earned on sale of one ton =$270 -$200 =$70

Depreciation = (Cost)/ life of the asset

=($2,760,000 )/5

=$552,000.

Cash outflow in the 0 year is investment in the machine +initial working capital i.e., $2,760,000+$252,000.=$3,012,000

Cash inflow in the year 5 is cash inflow in year 5 is profit earned from operatoins net of tax+ salvage value after tax+net working capital.+depreciation

=$798,760+$374,000*62%+$252,000+$552,000

=$1,834,640

Present value of cash inflows is as follows:

NPV =$3,108,570.75 - $3,012,000

=$96,570.75

Year Contribution earned (A) Fixed cost(B) Depreciation( C) Net profit (D =A-B-C) Profit after tax E=D*62% Cash inflow F=E+C Discount factor @16% (G) Present value H=F*G 1 $2,500,000.00 $800,000.00 $480,000.00 $1,220,000.00 $756,400.00 $1,236,400.00 0.862068966 $1,065,862.07 2 $2,500,000.00 $800,000.00 $480,000.00 $1,220,000.00 $756,400.00 $1,236,400.00 0.743162901 $918,846.61 3 $2,500,000.00 $800,000.00 $480,000.00 $1,220,000.00 $756,400.00 $1,236,400.00 0.640657674 $792,109.15 4 $2,500,000.00 $800,000.00 $480,000.00 $1,220,000.00 $756,400.00 $1,236,400.00 0.552291098 $682,852.71 5 $2,500,000.00 $800,000.00 $480,000.00 $1,220,000.00 $756,400.00 $1,733,200.00 0.476113015 $825,199.08 Total $4,284,869.62

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