Consider a project to supply Detroit with 40,000 tons of machine screws annually
ID: 2767444 • Letter: C
Question
Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,600,000 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 $600,000 and that variable costs should be $250 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 $450,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $340 per ton. The engineering department estimates you will need an initial net working capital investment of $560,000. You require a return of 14 percent and face a marginal tax rate of 30 percent on this project.
a-1 What is the estimated OCF for this project?
a-2 What is the estimated NPV for this project?
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?
Explanation / Answer
Base Case Best Case Worst case Tons sold in a year 40,000 40,000 40,000 Selling Price per Ton 340.00 374.00 306.00 Total Sales revenue 13,600,000 14,960,000 12,240,000 Variable cost per ton 250.00 250.00 250.00 Total Variable costs 10,000,000 10,000,000 10,000,000 Total Fixed costs 600,000 600,000 600,000 Gross Income 3,000,000 4,360,000 1,640,000 Assumed Net working capital is returned at the end Base Case NPV Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (5,600,000.00) NWC= (560,000.00) 560,000.00 Gross Income 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 Depreciation (933,333.33) (933,333.33) (933,333.33) (933,333.33) (933,333.33) (933,333.33) Salvage 450,000.00 Pretax Income 2,066,667 2,066,667 2,066,667 2,066,667 2,066,667 2,516,667 Less Tax @30% (620,000) (620,000) (620,000) (620,000) (620,000) (755,000) Post Tax Income 1,446,667 1,446,667 1,446,667 1,446,667 1,446,667 1,761,667 Add Back depreciation 933,333 933,333 933,333 933,333 933,333 933,333 a1 Net Operating Cash Flow(including NWC return)= (6,160,000.00) 2,380,000 2,380,000 2,380,000 2,380,000 2,380,000 3,255,000 PV factor @14% 1.00 0.877 0.769 0.675 0.592 0.519 0.456 PV of OCF (6,160,000.0) 2,087,719.3 1,831,332.7 1,606,432.2 1,409,151.1 1,236,097.4 1,482,934.2 a2 NPV = $ 3,493,666.92 b Best Case NPV Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (4,760,000.00) NWC= (532,000.00) 532,000.00 Gross Income 4,360,000 4,360,000 4,360,000 4,360,000 4,360,000 4,360,000 Depreciation (793,333.33) (793,333.33) (793,333.33) (793,333.33) (793,333.33) (793,333.33) Salvage 517,500.00 Pretax Income 3,566,667 3,566,667 3,566,667 3,566,667 3,566,667 4,084,167 Less Tax @30% (1,070,000) (1,070,000) (1,070,000) (1,070,000) (1,070,000) (1,225,250) Post Tax Income 2,496,667 2,496,667 2,496,667 2,496,667 2,496,667 2,858,917 Add Back depreciation 793,333 793,333 793,333 793,333 793,333 793,333 Net Operating Cash Flow(including NWC return)= (5,292,000.00) 3,290,000 3,290,000 3,290,000 3,290,000 3,290,000 4,184,250 PV factor @14% 1.00 0.877 0.769 0.675 0.592 0.519 0.456 PV of OCF (5,292,000.0) 2,885,964.9 2,531,548.2 2,220,656.3 1,947,944.1 1,708,722.9 1,906,288.0 NPV = $ 7,909,124.40 Worst Case NPV Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Investment (6,440,000.00) NWC= (588,000.00) 588,000.00 Gross Income 1,640,000 1,640,000 1,640,000 1,640,000 1,640,000 1,640,000 Depreciation (1,073,333.3) (1,073,333.3) (1,073,333.3) (1,073,333.3) (1,073,333.3) (1,073,333.3) Salvage 382,500.00 Pretax Income 566,667 566,667 566,667 566,667 566,667 949,167 Less Tax @30% (170,000) (170,000) (170,000) (170,000) (170,000) (284,750) Post Tax Income 396,667 396,667 396,667 396,667 396,667 664,417 Add Back depreciation 1,073,333 1,073,333 1,073,333 1,073,333 1,073,333 1,073,333 Net Operating Cash Flow(including NWC return)= (7,028,000.00) 1,470,000 1,470,000 1,470,000 1,470,000 1,470,000 2,325,750 PV factor @14% 1.00 0.877 0.769 0.675 0.592 0.519 0.456 PV of OCF (7,028,000.0) 1,289,473.7 1,131,117.3 992,208.1 870,358.0 763,471.9 1,059,580.4 NPV = $ (921,790.56)
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