Consider a project to supply Detroit with 40,000 tons of machine screws annually

ID: 2798868 • Letter: C

Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $3,900,000 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 $850,000 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 $460,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $330 per ton. The engineering department estimates you will need an initial net working capital investment of $480,000. You require a return of 10 percent and face a marginal tax rate of 38 percent on this project.

Suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. What is the sensitivity of the project OCF to changes in the quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

What is the sensitivity of NPV to changes in quantity supplied? (Do not round intermediate calculations and round your final answer to 2 decimal places, e.g., 32.16.)

Given the sensitivity number you calculated, what is the minimum level of output below which you wouldn’t want to operate? (Do not round intermediate calculations and round your final answer to the nearest whole number, e.g., 32)

Explanation / Answer

Step 1) initial investment = cost of equipment + WC rewuirement

= $3,900,000 + $480000 = $4380,000

Step 2) Depreciation = 3900,000/3 = $13,00,000

Step 3) Statement showing NPV

a) to calculate sensitivity to changes in quantity sold we will choose a quantity of 41000. The Annual cash flow and NPV at this level of Quantity

The sensitivity of change in OCF to quantity sold = change inOCF/change in quantity

=2000600-1951000 / 41000-40000

=49600/1000

=49.6

b) Sensitivity of NPV to change in quantity

=Change in NPV/ Change in quantity

=1170102-1046754/41000-40000

=123348.2/1000

=123.348

C) ome would'nt want NPV to fall below point of zero, from above it is clear that a unit change will increase or decrease NPV by 123.348$

NPV at level of 40000 unit/ Sensitivity of NPV

Change in quantity which would lead to NPV 0 = 1046754/123.348

=8486.185 units ie 8487 units

Thus minimum level of output below which one won't want to operate = 40000-8487 = 31513

Particulars 1 2 3 Total SPPU 330 330 330 VCPU 250 250 250 CPU 80 80 80 Total units 40000 40000 40000 Total contribution 3200000 3200000 3200000 Fixed cost 850000 850000 850000 Depreciation 1300000 1300000 1300000 PBT 1050000 1050000 1050000 Tax @ 38% 399000 399000 399000 PAT 651000 651000 651000 Add: depreciation 1300000 1300000 1300000 Annual cash flow 1951000 1951000 1951000 Salvage value(460000-38%) 285200 WC release 480000 Total cash flow 1951000 1951000 2716200 PVIF @10% 0.9091 0.8264 0.7513 PV 1773636 1612397 2040721 5426754 Less: initial inestment 4380000 NPV 1046754

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Consider a project to supply Detroit with 40,000 tons of machine screws annually

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Consider a project to supply Detroit with 40,000 tons of machine screws annually

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