Question

Consider a project to supply Detroit with 27,000 tons of machine screws annually for automobile production. You will need an initial $4,600,000 investment in threading equipment to get the project started; the project will last for 5 years. The accounting department estimates that annual fixed costs will be $1,100,000 and that variable costs should be $205 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 5-year project life. It also estimates a salvage value of $475,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $308 per ton. The engineering department estimates you will need an initial net working capital investment of $440,000. You require a return of 12 percent and face a tax rate of 23 percent on this project.

  

a-1.	What is the estimated OCF for this project? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
a-2.	What is the estimated NPV for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Suppose you believe that the accounting department’s initial cost and salvage value projections are accurate only to within ±5 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 ±15 percent. What are your worst-case and best-case NPVs for this project? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Answer (a-1):

Estimated OCF for this project = $1,505,970

Working:

Answer (a-2):

Estimated NPV for this project = $845,889.01

Working:

Answer b:

Best Case NPV = $3,384,930.68

Best case NPV will be when:

Initial cost is -5%

Salvage value is +5%

Price will be +10%

Working capital will be -15%

Workings:

Worst Case NPV = - $1,693,152.66

Worst case NPV will be when:

Initial cost is +5%

Salvage value is -5%

Price will be -10%

Working capital will be +15%

Workings: