Consider a project to supply Detroit with 20,000 tons of machine screws annually
ID: 2726990 • Letter: C
Question
Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,600,000 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 $850,000 and that variable costs should be $250 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 $250,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $380 per ton. The engineering department estimates you will need an initial net working capital investment of $360,000. You require a return of 16 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.) Whats the Worst-case $ Best-case $ PLEASE ANSWER PART B
Explanation / Answer
Answer to PART B: (Amount in $)
Particulars
Situation 1
Situation 2
Tons
20,000
20,000
Selling Price
418
342
Total Sales value
8360000
6840000
Initial Cost(Investment)
4140000
3060000
Salvage Value
287500
212500
Net working capital
378000
342000
Annual Fixed cost
850000
850000
Variable cost (250*20000)
5000000
5000000
Calculation of Cash Flow after Tax:
Particulars
Situation 1
Situation 2
Sales
8360000
6840000
Less: Variable Cost
5000000
5000000
Less: Fixed Cost
850000
850000
Profit from sale
2510000
990000
Less: Depreciation (SLM)
963125
711875
Cash flows before tax
1546875
278125
Less: Tax @38%
587813
105688
Cash flows after tax
959062
172437
Cash flows after tax but before depreciation
1922187
884312
Situation 1:
Year
Particulars
Cash Flow
Discounting Factor @16%
Discounted Cash flow
0
Initial Investment
(4140000)
1
(4140000)
0
Working Capital
(378000)
1
(378000)
1-4
Cash flows after tax before depreciation
1922187
2.7982
5378664
4
Working Capital
378000
0.5523
208769
4
Salvage Value
287000
0.5523
158510
Best Case NPV
1227943
Situation 2:
Year
Particulars
Cash Flow
Discounting Factor @16%
Discounted Cash flow
0
Initial Investment
(3060000)
1
(3060000)
0
Working Capital
(342000)
1
(342000)
1-4
Cash flows after tax before depreciation
884312
2.7982
2474482
4
Working Capital
342000
0.5523
188887
4
Salvage Value
212500
0.5523
117364
Worst Case NPV
(279267)
Notes : All the details taken above are after considering the data given in the question.
Particulars
Situation 1
Situation 2
Tons
20,000
20,000
Selling Price
418
342
Total Sales value
8360000
6840000
Initial Cost(Investment)
4140000
3060000
Salvage Value
287500
212500
Net working capital
378000
342000
Annual Fixed cost
850000
850000
Variable cost (250*20000)
5000000
5000000
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