Consider a project to supply Detroit with 30,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $4,400,000 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 $650,000 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 $260,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $390 per ton. The engineering department estimates you will need an initial net working capital investment of $440,000. You require a return of 18 percent and face a marginal tax rate of 30 percent on this project.

a-1 What is the estimated OCF for this project? (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.)

OCF $ 2,925,000

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 $ 1,898,317

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? (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

The above is the base case. In worst case, cost would higher, salvage value would be lower, price will be lower, NWC would be higher.

Best-case would be when initial cost is 15% lower, Salvage value is 15% higher, Price is 10% higher and NWC is 5% lower.

Detroit 0 1 2 3 Investment -$4,400,000 NWC -$440,000 $440,000 Salvage $260,000 Sales $11,700,000 $11,700,000 $11,700,000 VC -$7,500,000 -$7,500,000 -$7,500,000 FC -$650,000 -$650,000 -$650,000 Depreciation -$1,466,666.67 -$1,466,667 -$1,466,667 EBT $2,083,333 $2,083,333 $2,083,333 Tax (30%) -$625,000 -$625,000 -$625,000 Net Income $1,458,333 $1,458,333 $1,458,333 Cash Flows -$4,840,000 $2,925,000 $2,925,000 $3,547,000 NPV $1,898,316.72

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