Consider a project to supply Detroit with 20,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3,000,000 investment in threading equipment to get the project started; the project will last for four years. The accounting department estimates that annual fixed costs will be $850,000 and that variable costs should be $450 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the four-year project life. It also estimates a salvage value of $280,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $600 per ton. The engineering department estimates you will need an initial net working capital investment of $300,000. You require a 18 percent return and face a marginal tax rate of 38 percent on this project.

What is the estimated OCF for this project?

What is the estimated NPV for this project? (Round your answer 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 ±10 percent; and the engineering department’s net working capital estimate is accurate only to within ±5 percent. What is your worst-case and best-case scenario for this project? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

What is the estimated OCF for this project?

Explanation / Answer

YNPV = $1142060.95

Notes:a. Total Cash flow(discounted@18%) for this project is

NPV=$1142,060.95 (sum of present values)

b)The figures 1.18, 1.3924, 1.64303, 1.93878 are calculated as below: 1.181 ,1.182,1.183,1.184. These are the discounting factors, which discount the respective cash flow after taxes to the present values. We divide $1618000 by 1.18 to get 1371186 ,$1618000(year 2) by 1.3924 to get $1162022 and so on. c) The tax rate is 38%, so we multiply the salvage value by 62% (100-38) to get $173,600. Salvage value before tax is $280,000 - if we deduct (38% of $280,000 ) from it, we will arrive at the same figure.d) SP means Selling Price, VC means Variable cost, PBT is Profit before tax, PAT is Profit after tax.SP - VC = Contribution per unit.

Now we can do part b) which is also called sensitivity analysis:

b)

So by changing the selling price, we can change the NPV considerably- when SP is $540, there is a negative NPV of $522776.We are showing calculations for SP=$565 below:

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