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 $3,600,000 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 $250 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 $250,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $380 per ton. The engineering department estimates you will need an initial net working capital investment of $360,000. You require a return of 16 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

OCF = Net Income + Depreciation = 527,000 + 3,600,000 / 4 = 1,427,000

NPV = NPV(16%, 1427000...1942000) - 3960000 = $317,433.69

b) Worst case NPV is when price is down and costs are up.

Worst case NPV = -1,418,421.89

Best case NPV is when price is up and cost are down.

Best-case NPV = $2,053,289.26

Detroit 0 1 2 3 4 Investment -$3,600,000 NWC -$360,000 $360,000 Salvage $250,000 Sales $7,600,000 $7,600,000 $7,600,000 $7,600,000 VC -$5,000,000 -$5,000,000 -$5,000,000 -$5,000,000 FC -$850,000 -$850,000 -$850,000 -$850,000 Depreciation -$900,000 -$900,000 -$900,000 -$900,000 EBT $850,000 $850,000 $850,000 $850,000 Tax (38%) -$323,000 -$323,000 -$323,000 -$323,000 Net Income $527,000 $527,000 $527,000 $527,000 Cash Flows -$3,960,000 $1,427,000 $1,427,000 $1,427,000 $1,942,000 NPV $317,433.69

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