Consider a project to supply Detroit with 25,000 tons of machine screws annually
ID: 2804651 • Letter: C
Question
Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,600,000 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 $650,000 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 $600,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 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. Enter your answer in whole dollars, not millions of dollars, e.g., 1,234,567.)
What is the estimated NPV for this project? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and 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 is the worst-case NPV for this project? The best-case NPV? (A negative answer should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer 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 $2,600,000 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 $650,000 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 $600,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project.
Explanation / Answer
Given, fixed cost = 2,600,000 and working capital requirement = 260,000
Initial outlay = FCinv + WCinv
= 2600,000+260,000
=2860,000
The asset will depreciate on SLM basis to zero over 5 years
thus depreciation per year = 2600,000 / 5 = 520,000
Terminal value = Salvage + WCinv - tax*(salvage-bookvalue)
=600,000+260,000 - 0.38*(600,000-0)
=860,000 - 228000
=632,000
Answer a-1.
Sales = Price*units = 290*25000 = 7250,000
Variable cost = 200*25000 = 5000,000
Fixed cost = 650,000
Total cost = 5000,000+650,000 = 5650,000
OCF = sales-cost-depreciation*(1-tax) + Depreciation
=(7250,000-5650,000-520,000)*(1-0.38) + 520,000
=1189600
Answer a-2.
NPV at 12% required return is:
Year
Cashflow
0
-2860000
1
1189600
2
1189600
3
1189600
4
1189600
5
1821600
NPV at 12%
$1,595,406.73
Given, the initial cost can be in the range of +-15% thus fixed cost = 2,600,000
Hence worst case FCinv = 2600,000*(1-0.15) = 2210,000
Best case FCinv = 2600,000*(1+0.15) = 2990,000
and,
the net working capital can be in the range of +-5% thus working capital = 260,000
Hence worst case WCinv = 260,000*(1-0.05) = 247,000
Best case WCinv = 260,000*(1+0.05) = 273,000
Worst case Initial outlay = FCinv + WCinv
= 2210,000+247,000
= 2457,000
Best case Initial outlay = FCinv + WCinv
= 2990,000+273,000
= 3263,000
Salvage value is +-15% thus salvage = 600,000
Worst case salvage value = 600,000*(1-0.15) = 510,000
Best case salvage value = 600,000*(1+0.15) = 690,000
Thus worst case terminal cashflow = 510,000+247,000 - 0.38*(510,000-0)
= 757,000 - 193800
= 563200
Best case terminal cashflow = 690,000+273,000 - 0.38*(690,000-0)
=963000 - 262,200
=700,800
The sales price for can be in the range of +-10%
thus worst case Sales = Price*units = 290*(1-0.10)*25000 = 6525,000
best case sales = Price*units = 290*(1+0.10)*25000 = 7975,000
Variable cost = 200*25000 = 5000,000
Fixed cost = 650,000
Total cost = 5000,000+650,000 = 5650,000
Worst case OCF = sales-cost-depreciation*(1-tax) + Depreciation
=(6525,000-5650,000-520,000)*(1-0.38) + 520,000
=740,100
Best case OCF = sales-cost-depreciation*(1-tax) + Depreciation
=(7975,000-5650,000-520,000)*(1-0.38) + 520,000
=1639100
Best and worst case NPV at 12% is:
Year
Worst case
Best case
0
-2457000
-3263000
1
740100
1639100
2
740100
1639100
3
740100
1639100
4
740100
1639100
5
1276300
2339900
NPV at 12%
$459,954.60
$2,717,179.83
Year
Cashflow
0
-2860000
1
1189600
2
1189600
3
1189600
4
1189600
5
1821600
NPV at 12%
$1,595,406.73
You can also find NPV by inserting respective cashflows in the financial calculator and pressing CPT NPV at 12%Related Questions
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