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 $4,400,000 investment in threading equipment to get the project started; the project will last for three years. The accounting department estimates that annual fixed costs will be $650,000 and that variable costs should be $250 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the three-year project life. It also estimates a salvage value of $260,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $390 per ton. The engineering department estimates you will need an initial net working capital investment of $440,000. 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 30,000 tons of machine screws annually for automobile production. You will need an initial $4,400,000 investment in threading equipment to get the project started; the project will last for three years. The accounting department estimates that annual fixed costs will be $650,000 and that variable costs should be $250 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the three-year project life. It also estimates a salvage value of $260,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $390 per ton. The engineering department estimates you will need an initial net working capital investment of $440,000. You require a return of 18 percent and face a marginal tax rate of 30 percent on this project.

Explanation / Answer

The OCF and NPV at the given level of 30,000 screws is as shown below:

Now we will recaluclate the OCF and NPV at 25,000 ton level

a. The change in OCF/ Change in Quantity = (2925000 -2435000)/(30000-25000) = 490000/5000 = 98

b. The chnage in NPV / change in Quantity = 1,065,393.74/5000 = 213.08

c. Minimum level of output fro profitabilty = 21,092 tons of machine screws

Year 0 1 2 3 Initial Investment -4400000 Initial WC -440000 Revenue 11700000 11700000 11700000 Variable Costs -7500000 -7500000 -7500000 Fixed Costs -650000 -650000 -650000 Depreciation -1466667 -1466667 -1466667 Profit before tax 2083333 2083333 2083333 Tax at 30% -625000 -625000 -625000 Profit after tax 1458333 1458333 1458333 Add back dpereciation 1466667 1466667 1466667 Add back WC 440000 After tax salavage value 182000 OCF -4840000 2925000 2925000 3547000 NPV $     1,898,316.72

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