Consider a project to supply Detroit with 30,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $3,800,000 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 $600,000 and that variable costs should be $350 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 $340,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $450 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. You require a 12 percent return and face a marginal tax rate of 38 percent on this project.

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?

Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $3,800,000 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 $600,000 and that variable costs should be $350 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 $340,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $450 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. You require a 12 percent return and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

Present case

Case 1

Case 2

Initial cost

3800000

3230000

Working capital investment

380000

399000

361000

Present value factor @12%

1

1

1

Present value of cash outflow

4180000

4769000

3591000

Present case

Case 1

Case 2

Initial cost

3800000

4370000

3230000

Working capital investment

380000

399000

361000

Present value factor @12%

1

1

1

Present value of cash outflow

4180000

4769000

3591000

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