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

$ ________

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.

Explanation / Answer

Solution.

Calculation of OCF.

OCF = (Sales - Cost)(1 - tax rate) + (tax rate x Depreciation)
OCF = 2,100,000(.70) + [.30 x 733,334]
OCF = 1,470,000 + 220,000
OCF = 1,690,000

1.b.

Salvage value amount is after 30% tax deduction.

Year Cash flow Table value @ 15% PV 0    (5,500,000.00)              1.0000           (5,500,000) 1      1,690,000.00              0.8695             1,469,455 2      1,690,000.00              0.7561             1,277,809 3      1,690,000.00              0.6575             1,111,175 4      1,690,000.00              0.5717                 966,173 5      1,690,000.00              0.4971                 840,099 6      1,690,000.00              0.4323                 730,587 Salvage value          600,000.00              0.4323                 181,566 Working Capital          500,000.00              0.4323                 216,250 NPV             1,293,114

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