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 $4,800,000 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 $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 three-year project life. It also estimates a salvage value of $460,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $330 per ton. The engineering department estimates you will need an initial net working capital investment of $480,000. You require a return of 10 percent and face a marginal tax rate of 38 percent on this project.

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a-1 What is the estimated OCF for this project? (Do not round intermediate calculations.) 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 is the worst-case NPV for this project? The best-case NPV (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.Using the tax shield approach, the OCF is

1.OCF = (($330 – 250)(40,000) – $850,000)(0.62) + 0.38($4,800,000/3)OCF = $2,065,000

2.NPV = –$4,800,000 – 480,000 + $2,065,000(PVIFA10%,3)+ ($480,000 + $460,000(1 – .38)]/(PVIF 10%,3)

NPV = $430,255

b.

OCF worst = (($330(0.9) – 250)(40,000) – $850,000)(0.62) + 0.38($4,800,000(1.15)/3)OCF = $1337,800

NPV worst = –$4,800,000(1.15) –480,000(1.05) + $1337,800(PVIFA10%,3)+ ($480,000(1.05) + $460,000(0.85)(1 – .38)]/(PVIF 10%,3)

NPV worst = ($2136,293)

OCF best = (($330(1.1) – 250)(40,000) – $850,000)(0.62) + 0.38($4,800,000(.85)/3)

OCF best = $2,792,200

NPV best = –$4,800,000(.85) –480,000(.95) +2,792,200 (PVIFA10%,3)+ ($480,000(0.95) + $460,000(1.15)(1 – .38)]*(PVIF 10%,3)

NPV best = $2996,804

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