Consider a project to supply Detroit with 20,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,200,000 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 $700,000 and that variable costs should be $200 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 $350,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $310 per ton. The engineering department estimates you will need an initial net working capital investment of $320,000. You require a return of 13 percent and face a marginal tax rate of 38 percent on this project.

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,200,000 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 $700,000 and that variable costs should be $200 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 $350,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $310 per ton. The engineering department estimates you will need an initial net working capital investment of $320,000. You require a return of 13 percent and face a marginal tax rate of 38 percent on this project.

a-1 What is the estimated OCF for this project? (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.) OCF a-2 What is the estimated NPV for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) NPV b. 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 are your worst-case and best-case NPVs for this project? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Worst-case Best-casee

Explanation / Answer

a-1) $1,234,000

a-2) $479,875

Calculations:

b) Worst case = -$1,034,036

Best case =$1,993,786

Workings:

INITIAL INVESTMENT: cost of equipment 3200000 net working capital 320000 Total initial investment 3520000 OPERATING CASH FLOWS: incremental contribution (20000*310-200) 2200000 less: fixed costs 700000 less: depreciation (3200000/4) 800000 net income before tax 700000 tax @ 38% 266000 net income after tax 434000 add: depreciation 800000 Net operating cash flows 1234000 TERMINAL CASH FLOWS: salvage value 350000 tax @ 38% on gain of 350000 133000 Net salvage value 217000 release of NWC 320000 Net terminal cash inflows 537000 NPV: PV of annual OCF = 1234000*pvifa(13,4) = 1234000*2.9745 = 3670533 PV of terminal cash flow = 537000*pvif(13,4) = 537000*0.6133 = 329342 Total PV of cash inflows 3999875 Less: Initial investment 3520000 NPV 479875

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