Consider a project to supply Detroit with 40,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,000,000 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 $300 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 $600,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $370 per ton. The engineering department estimates you will need an initial net working capital investment of $500,000. You require a return of 15 percent and face a marginal tax rate of 30 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-case $___________

Explanation / Answer

a-1)

   Calculation of Operating cash flows (OCF)

Contribution (370 - 300) * 40000

(-) Fixed costs

2800000

700000

Gross income

(-) Depreciation [5000000 - 600000] / 6

2100000

733333.33

Earnings before interest & Tax

(-) Tax @ 30 %

1366666.67

410000

Earnings after tax

(+) Depreciation

956666.67

733333.33

Conclusion:- Operating cash flow (OCF) = $ 1690000

a-2) Estimated NPV of project = Present value of cash inflow - P.V. of cash outflow

   = 6870160 (ii) - 5500000 (i) = $ 1370160 (approx)

   i) P.V. of cash outflow = 5000000 + 500000 = $ 5500000

   ii) P.V. of Cash inflow:-

P.V. of OCF = 1690000 * Cumulative P.V. Factor for 6 Years @ 15 %

= 1690000 * 3.784

Conclusion:- Estimated NPV of project = $ 1370160.

Contribution (370 - 300) * 40000

(-) Fixed costs

2800000

700000

Gross income

(-) Depreciation [5000000 - 600000] / 6

2100000

733333.33

Earnings before interest & Tax

(-) Tax @ 30 %

1366666.67

410000

Earnings after tax

(+) Depreciation

956666.67

733333.33

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