Consider a project to supply Detroit with 25,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,600,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $650,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-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 $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project.

  

What is the estimated OCF for this project? (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.)

  

  

What is the estimated NPV for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)

  

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.)

  

Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,600,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $650,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-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 $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

a1. The operating cash flow for all the five years is calculated as follows:

Hence OCF annually = $1,189,600

a2. The NPV of the project is calculated as follows:

The NPV = $1,786,855.54

b: Worst Case: Intial Cost + 15%, Salavge Value -15%, Price , -10% and Inital WC = +5%. The new NPV table is as shown below:

NPV = -153,931.66 (Negative)

d: Best Case:Intial Cost -15%, Salavge Value +15%, Price , +10% and Inital WC = -5%. The new NPV table is as shown below:

The best case NPV = $3,727,642.75

Year 0 1 2 3 4 5 Intial Cost -2600000 Initial Working capital -260000 Revenue 7250000 7250000 7250000 7250000 7250000 Variable Costs 5000000 5000000 5000000 5000000 5000000 Fixed Costs 650000 650000 650000 650000 650000 Depreciation 520000 520000 520000 520000 520000 Profit before tax 1080000 1080000 1080000 1080000 1080000 tax at 38% 410400 410400 410400 410400 410400 Net Income 669600 669600 669600 669600 669600 Add back depreciation 520000 520000 520000 520000 520000 After tax salavage Value 372000 Return of working capital 260000 Operating cash flow (OCF) 1189600 1189600 1189600 1189600 1821600

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