Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $5,400,000 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 $850,000 and that variable costs should be $440 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 $380,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $560 per ton. The engineering department estimates you will need an initial net working capital investment of $540,000. You require a return of 12 percent and face a marginal 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 enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

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 is the worst-case NPV for this project? The best-case NPV?

Answer 1

Answer a-1:

Contribution per ton = sales price - variable cost = $560 - $440 = $120

Operating cash flow = (Contribution per ton * Tons sold - Fixed cost) * (1 - Tax rate) + Depreciation tax shield

= (120 * 40000 -850000) * (1 - 23%) + (5400000 / 5) * 23%

= $3,289,900

Operating cash flow = $3,289,900

Answer a-2:

NPV = $6,391,792.83

Working:

The above excel with 'show formula' is follows:

Answer b:

Worst case NPV = ($537,994.04)

Worst case NPV will be when:

Initial cost increases by 15% to $6210000

Salvage value decreases by 15% to $323,000

Price decreases by 10% to $504

Working capital increases by 5% to $567,000

Working:

Best case NPV = $13,321,580.70

Best case NPV will be when:

Initial cost decreases by 15% to $4,590,000

Salvage value increases by 15% to $437,000

Price increases by 10% to $616

Working capital decreases by 5% to $513,000

Working: