Consider a project to supply Detroit with 40,000 tons of machine screws annually
ID: 2726741 • 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 $6,000,000 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 $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 six-year project life. It also estimates a salvage value of $680,000 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 $580,000. You require a return of 18 percent and face a marginal tax rate of 30 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, e.g., 32)
Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $6,000,000 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 $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 six-year project life. It also estimates a salvage value of $680,000 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 $580,000. You require a return of 18 percent and face a marginal tax rate of 30 percent on this project.
Explanation / Answer
Assume two demand situations : 40,000 Tons per year & 30,000 Toms per year Situation 1 : Qty 40,000 Tons Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (6,000,000) Net working capital (580,000) 580,000 Sales revenue @$300Per ton 12,000,000 12,000,000 12,000,000 12,000,000 12,000,000 12,000,000 Variable Cost (8,000,000) (8,000,000) (8,000,000) (8,000,000) (8,000,000) (8,000,000) Fixed cost (700,000) (700,000) (700,000) (700,000) (700,000) (700,000) Depreciation (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) Salvage 680,000 Taxable income 2,300,000 2,300,000 2,300,000 2,300,000 2,300,000 2,980,000 Tax @30% (690,000) (690,000) (690,000) (690,000) (690,000) (894,000) Post Tax Income 1,610,000 1,610,000 1,610,000 1,610,000 1,610,000 2,086,000 Add back depreciation 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Net Operating Cash Flow (with NWC) (6,580,000) 2,610,000 2,610,000 2,610,000 2,610,000 2,610,000 3,666,000 PV factor @18% 1 0.847 0.718 0.609 0.516 0.437 0.370 PV of Cash Flows = (6,580,000) 2,211,864 1,874,461 1,588,527 1,346,209 1,140,855 1,358,002 NPV = $ 2,939,918.4 OCF per year = 2,610,000 Situation 2 : Qty 30,000 Tons Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (6,000,000) Net working capital (580,000) 580,000 Sales revenue @$300Per ton 9,000,000 9,000,000 9,000,000 9,000,000 9,000,000 9,000,000 Variable Cost (6,000,000) (6,000,000) (6,000,000) (6,000,000) (6,000,000) (6,000,000) Fixed cost (700,000) (700,000) (700,000) (700,000) (700,000) (700,000) Depreciation (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) Salvage 680,000 Taxable income 1,300,000 1,300,000 1,300,000 1,300,000 1,300,000 1,980,000 Tax @30% (390,000) (390,000) (390,000) (390,000) (390,000) (594,000) Post Tax Income 910,000 910,000 910,000 910,000 910,000 1,386,000 Add back depreciation 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Net Operating Cash Flow (with NWC) (6,580,000) 1,910,000 1,910,000 1,910,000 1,910,000 1,910,000 2,966,000 PV factor @18% 1 0.847 0.718 0.609 0.516 0.437 0.370 PV of Cash Flows = (6,580,000) 1,618,644 1,371,732 1,162,485 985,157 834,879 1,098,700 NPV = $ 491,596.6 OCF = 1,910,000 Sensitivity of OCF with Qty Scenario 1 Scenario 2 Change Yearly Qty 40,000 30,000 10,000 OCF per year 2,610,000 1,910,000 700,000 Sensitivity Change in OCF/Change in Qty= $ 70.00 per Ton Sensitivity of NPV with Qty Scenario 1 Scenario 2 Change Yearly Qty 40,000 30,000 10,000 NPV = 2,939,918 491,597 2,448,322 Sensitivity of Change in NPV/Change in Qty= $ 244.83 per Ton Mon operating qty when NPV =0 Situation 2 : Qty 27992 Tons Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (6,000,000) Net working capital (580,000) 580,000 Sales revenue @$300Per ton 8,397,600 8,397,600 8,397,600 8,397,600 8,397,600 8,397,600 Variable Cost (5,598,400) (5,598,400) (5,598,400) (5,598,400) (5,598,400) (5,598,400) Fixed cost (700,000) (700,000) (700,000) (700,000) (700,000) (700,000) Depreciation (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000) Salvage 680,000 Taxable income 1,099,200 1,099,200 1,099,200 1,099,200 1,099,200 1,779,200 Tax @30% (329,760) (329,760) (329,760) (329,760) (329,760) (533,760) Post Tax Income 769,440 769,440 769,440 769,440 769,440 1,245,440 Add back depreciation 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 Net Operating Cash Flow (with NWC) (6,580,000) 1,769,440 1,769,440 1,769,440 1,769,440 1,769,440 2,825,440 PV factor @18% 1 0.847 0.718 0.609 0.516 0.437 0.370 PV of Cash Flows = (6,580,000) 1,499,525 1,270,784 1,076,936 912,657 773,439 1,046,632 NPV = $ (26) So at annula operating level 27992 Tons, the NPV is 0. So Min level of output should be 27993 Tons
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.