Consider a project to supply Detroit with 25,000 tons of machine screws annually

Question

Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,400,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $440,000 after dismantling 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 $240,000. You require a return of 16 percent and face a marginal tax rate of 38 percent on this project.

  

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

  

  

What is the estimated NPV for this project? (Do not round intermediate calculations. 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 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.)

  

Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,400,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $800,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $440,000 after dismantling 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 $240,000. You require a return of 16 percent and face a marginal tax rate of 38 percent on this project.

Explanation / Answer

OCF = 1,236,400

NPV = 1,652,487.43

Best-case NPV would have higher price and higher salvage value, while lower cost and working capital

Worst-case NPV would have lower price and lower salvage value, while higher cost and working capital.

Best-case NPV = $3,471,218.49

Worst-case NPV = - $166,243.64

Detroit 0 1 2 3 4 5 Investment -$2,400,000 NWC -$240,000 $240,000 Salvage $440,000 Sales $7,500,000 $7,500,000 $7,500,000 $7,500,000 $7,500,000 VC -$5,000,000 -$5,000,000 -$5,000,000 -$5,000,000 -$5,000,000 FC -$800,000 -$800,000 -$800,000 -$800,000 -$800,000 Depreciation -$480,000 -$480,000 -$480,000 -$480,000 -$480,000 EBT $1,220,000 $1,220,000 $1,220,000 $1,220,000 $1,220,000 Tax (38%) -$463,600 -$463,600 -$463,600 -$463,600 -$463,600 Net Income $756,400 $756,400 $756,400 $756,400 $756,400 Cash Flows -$2,640,000 $1,236,400 $1,236,400 $1,236,400 $1,236,400 $1,749,200 NPV $1,652,487.43

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