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 $5,200,000 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. Suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. a. What is the sensitivity of the project OCF to changes in the quantity supplied?

Explanation / Answer

Solution.

Sales      14,800,000.00 Variable cost    (12,000,000.00) Opereting Income         2,800,000.00 Fixed cost          (700,000.00) Depreciation          (766,667.00) EBIT         1,333,333.00 Tax @30%          (399,999.90) EAT            933,333.10 Depreciation            766,667.00 OCF         1,700,000.10

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