Consider a project to supply Detroit with 45,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 45,000 tons of machine screws annually for automobile production. You will need an initial $1,980,000 investment in threading equipment to get the project started; the project will last for 6 years. The accounting department estimates that annual fixed costs will be $450,000 and that variable costs should be $210 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 6-year project life. It also estimates a salvage value of $491,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $230 per ton. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 11 percent return and face a marginal tax rate of 36 percent on this project.

The estimated OCF for this project is _________$ and the NPV is __________$. (Do not include the dollar signs ($). Negative amounts should be indicated by a minus sign. Round your answers 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 ±9 percent; and the engineering department's net working capital estimate is accurate only to within ±4 percent. Your worst-case NPV for this project is __________$ and your best-case NPV is _________$. (Do not include the dollar signs ($). Negative amount should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

Consider a project to supply Detroit with 45,000 tons of machine screws annually for automobile production. You will need an initial $1,980,000 investment in threading equipment to get the project started; the project will last for 6 years. The accounting department estimates that annual fixed costs will be $450,000 and that variable costs should be $210 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 6-year project life. It also estimates a salvage value of $491,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $230 per ton. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 11 percent return and face a marginal tax rate of 36 percent on this project.

Explanation / Answer

(a) Statement showing Calculation of operating cash flows

Calculation of NPV

NPV = P.V. of cash inflows - P.V. of cash out flows

Statement showing Calculation of NPV

(b) Worst Case NPV

Worst case variables

Selling price = 230-230x9% = 209.30

Initial nvestment = 1980000x115% = 2277000

Wrking capital = 450000x104% = 468000

Salvage value = 491000x85% = 417350

Statement showing Calculation of operating cash flows

Calculation Of OCFs

Worst case NPV = -1208468.80 - 2745000 =(3953468.80)

Best Case NPV

Best case variables

Initial Cost = 1980000x85% = 1683000

Salvage value = 491000x115% = 54650

Selling price = 230x109% = 250.70

Working capital = 450000x104% = 432000

Statement showing Calculation of operating cash flows

Calculation Of OCFs

Worst case NPV = 2284247.34

Annual supply 45000 tons Selling price per ton 230 Less: Variable cost per ton 210 Contribution 20 Total contribution 900000 Less: Fixed cost per annum 450000 Operating cash flows before tax 450000 Less: Tax @ 36% 162000 Add: Tax savings on Depreciation (1980000/6)x36% 118800 Cash flows after Tax 406800

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