Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $4,800,000 investment in threading equipment to get the project started; the project will last for 3 years. The accounting department estimates that annual fixed costs will be $850,000 and that variable costs should be $220 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 3-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 13 percent and face a marginal tax rate of 25 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? (A negative answer should be indicated by a minus sign. 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.)

Answer 1

a) The calculation for estimated OCF and estimated NPV are given below:

b) The calculation for Best and Worst case NPV is given below:

1 a) Calculation 3 Year 4 Sales Revenue 5 Variable cost Annual Fixed Costs 7 Taxable Cash flows 8 Taxation at 25% 9 Tax savings on depreciation 10 Initial Investment 11 Working Capital 12 Salvage Value 13 Net cashflows 14 Discount factor @ 13% 15 Present value of cashflows 13,200,000.00 -8,800,000.00 -850,000.00 3,550,000.00 -887,500.00 400,000.00 0.00 13,200,000.00 13,200,000.00 $330 * 40,000 units -8,800,000.00 -8,800,000.00 $220 * 40,000 units -850,000.00 -850,000.00 Given in the question 3,550,000.00 3,550,000.00 -887,500.00 -887,500.00 Taxable cash flow * 25% Tax rate 400,000.00 400,000.00 $4,800,000/3 * 25% tax rate Given in the question 480,000.00 Given in the question 460,000.00 Given in the question 3,062,500.00 4,002,500.00 0.783 0.693 (1 + 0.13) - 2,398,386.722,773,933.27 -4,800,000.00 -480,000.00 -5,280,000.00 1.000 -5,280,000.00 3,062,500.00 0.885 2,710,176.99 17 Estimated Total OCF $4,847,500.00 18 19 Estimated NPV $2,602,496.98

23 Best Case NPV 25 26 Initial cost will decrease by 15% and Salvage value will increase by 15%. Selling Price will increase by 10%. Net Working Capital will decrease by 5% 14,520,000.00 -8,800,000.00 -850,000.00 4,870,000.00 -1,217,500.00 400,000.00 14,520,000.00 -8,800,000.00 -850,000.00 4,870,000.00 -1,217,500.00 400,000.00 0.00 28 Year 29 Sales Revenue 30 Variable cost 31 Annual Fixed Costs 32 Taxable Cash flows 33 Taxation at 25% 34 Tax savings on depreciation 35 Initial Investment 36 Working Capital 37 Salvage Value 38 Net cashflows 39 Discount factor @ 13% 40 Present value of cashflows 41 42 Best Case NPV 14,520,000.00 ($330*1.10) * 40,000 units -8,800,000.00 $220 * 40,000 units -850,000.00 Given in the question 4,870,000.00 -1,217,500.00 Taxable cash flow * 25% Tax rate 400,000.00 $4,800,000/3 * 25% tax rate $4,800,000 *(1-0.15) 456,000.00 $480,000 *(1-0.05) 529,000.00 $460,000 * 1.15 5,037,500.00 0.693 (1 + 0.13) -- 3,491,240.19 -4,080,000.00 -456,000.00 -4,536,000.00 1.000 -4,536,000.00 4,052,500.00 4,052,500.00 0.885 0.783 3,586,283.193,173,701.93 $5,715,225.31 43