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 S3,400,000 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 $800,000 and that variable costs should be $180 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 $620,000 after costs. The marketing department estimates that the automakers will let the contract at a selling price of $300 per ton. The engineering department estimates you will need an initial net working capital investment of $340,000. You require a return of 11 percent and face a marginal tax rate of 38 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 1315000 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 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

Step 1) Initial investment

Purchase price of threading equipment + initial working capital

=3400000+340000

=$37,40,000

Step 2) depreciation = 3400,000/4= 850,000$

Step 3) Statement showing NPV

Worst case scenario :

Initial investment = (3400,000*1.15)+(340000*1.05)

=3910000+357000

=4267000$

Depreciation = 3910,000/4 = 977500

Salvage value = 620,000(0.85) = 527000

Statement showing Worst case NPV

Best case scenario :

Initial investment = (3400,000*0.85)+(340000*0.95)

=2890000+323000

=3213000$

Depreciation = 2890000/4 = 722500

Salvage value = 620,000(1.15) = 713000

Statement showing Best case NPV

Particulars 1 2 3 4 Total SPPU 300 300 300 300 VCPU 180 180 180 180 CPU 120 120 120 120 Units 20000 20000 20000 20000 Contribution 2400000 2400000 2400000 2400000 Fixed cost 800000 800000 800000 800000 Depreciation 850000 850000 850000 850000 PBT 750000 750000 750000 750000 Tax @ 38% 285000 285000 285000 285000 PAT 465000 465000 465000 465000 Add :Depreciation 850000 850000 850000 850000 Annual cash flow 1315000 1315000 1315000 1315000 Salvage value(620000-38%) 384400 Release of WC 340000 Total cash flow 1315000 1315000 1315000 2039400 PVIF @ 11% 0.9009 0.8116 0.7312 0.6587 PV 1184685 1067283 961516.7 1343416 4556901 Less: initial investment 3740000 NPV 816901

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