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 $2,000,000 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 $300 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 $220,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $360 per ton. The engineering department estimates you will need an initial net working capital investment of $200,000. You require a return of 10 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 $________

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

Initial Investment 2000000 Net Working capital 200000 Salvage value 220000 Annual sales (Tons) 25000 360 Fixed cost 800000 Variable cost (per ton) 300 ROR 10 % Tax Rate 38 % (i) OCF - Sales (25000 x 360) 9000000 Less: Variable cost (25000 x 300) 7500000 Contribution 1500000 Less: Fixed cost 800000 Less: Depreciation (2000000/5) 400000 EBIT 300000 Less: Tax @ 38% 114000 PAT 186000 Add: Depreciation 400000 OCF 586000 (ii) NPV = Years 0 1 to 4 5 Initial Investment -2000000 NWC -200000 200000 OCF 586000 586000 Salvage Value 136400 (220000 x (1-0.38)) Net cash flows -2200000 586000 922400 PV Factors @ 10% 1 3.1699 0.620921 PV of cash flows -2200000 1857541 572737.8 NPV = 230279 (iii) % Change Worst case Normal Best case Initial Investment 15%+- 2300000 2000000 1700000 NWC 5%+- 210000 200000 190000 Selling price 10%+- 324 360 396 Salvage value 15%+- 187000 220000 253000 (a) OCF - Worst case Normal Best case Sales (25000 x SP P.t) 8100000 9000000 9900000 Less: Variable cost (25000 x 300) 7500000 7500000 7500000 Contribution 600000 1500000 2400000 Less: Fixed cost 800000 800000 800000 Less: Depreciation (initial investment/5) 460000 400000 340000 EBIT -660000 300000 1260000 Less: Tax @ 38% -250800 114000 478800 PAT -409200 186000 781200 Add: Depreciation 460000 400000 340000 OCF 50800 586000 1121200 (b) Worst case Normal Best case Salvage value 187000 220000 253000 Less: Tax 71060 83600 96140 Post tax salvage value 115940 136400 156860 ( c) NPV - Worst case Normal Best case OCF 50800 586000 1121200 PVAF(10%,5) 3.7908 3.7908 3.7908 PV of OCF (A) 192572 2221401 4250230 Post tax salvage value 115940 136400 156860 PV Factors (10%,5) 0.620921 0.620921 0.620921 PV of post tax salvage value (B) 71989.62 84693.67 97397.72 NWC Recovered 210000 200000 190000 PV of Recovery of NWC (C ) 130393.5 124184.3 117975.1 Initial Investment (D) -2300000 -2000000 -1700000 NWC (E) -210000 -200000 -190000 NPV (A + B + C + D + E) -2115045 230279 2575603 Worst case NPV -2115045 Best case NPV 2575603 Please provide feedback……... thanks in advance……… :-)

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