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In: Accounting

Ironlove Inc. considers a project to supply a car manufacturer with 105,000 tons of steel plates...

Ironlove Inc. considers a project to supply a car manufacturer with 105,000 tons of steel plates annually for five years. It requires an initial investment of 42 million dollars in steel plate production machinery. The variable cost of the production is $430 per ton. The overhead cost will be 15 million dollars a year, and the company estimates the price of the steel plates at $950 per ton. To run this project, Ironlove needs to invest 8 million dollars in the net working capital at time zero.

The machinery belongs to Class 6, with a CCA rate of 15%. The company estimates that it can sell the machinery at a salvage value of 12 million dollars. Assume the company requires a 15% rate of return, and the tax rate is 40%.

Suppose you believe that the accounting department’s initial cost and salvage value projections are accurate only to within ±20%; the marketing department’s steel price estimate is accurate only within ±15%, and the net working capital estimate is accurate only to within ±10%. What is your worst-case and best-case scenario for this project?

Solutions

Expert Solution

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial cost (42000000)
New Working capital (8000000)
Sales 99750000 99750000 99750000 99750000 99750000
Less- Variable cost 45150000 45150000 45150000 45150000 45150000
Less- Overhead Cost 15000000 15000000 15000000 15000000 15000000
Less- Depreciation 6300000 5355000 4551750 3868987.5 3288639.4
Earnings before interest and tax 33300000 34245000 35048250 35731013 36311361
Less: Tax @ 40% 13320000 13698000 14019300 14292405 14524544
Net Income 19980000 20547000 21028950 21438608 21786816
Add: Depreciation 6300000 5355000 4551750 3868987.5 3288639.4
Add: Recovery of net working capital 8000000
Add: After tax salvage value (W.N..) 14654249
Operating cash flows (OCF) (50000000) 26280000 25902000 25580700 25307595 47729705
PV factors @ 15% 1 0.8695652 0.7561437 0.6575162 0.5717532 0.4971767
Present value (50000000) 22852174 19585633 16819725 14469700 23730099
Net Present Value (NPV) 47457331

W.Note

Sale proceeds 12000000
Cost 18635623
Loss -6635623
Tax savings @40% -2654249
After tax salvage value 14654249
BEST CASE
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial cost (50400000)
New Working capital (8800000)
Sales 114712500 114712500 114712500 114712500 114712500
Less- Variable cost 45150000 45150000 45150000 45150000 45150000
Less- Overhead Cost 15000000 15000000 15000000 15000000 15000000
Less- Depreciation 7560000 6426000 5462100 4642785 3946367.3
Earnings before interest and tax 47002500 48136500 49100400 49919715 50616133
Less: Tax @ 40% 18801000 19254600 19640160 19967886 20246453
Net Income 28201500 28881900 29460240 29951829 30369680
Add: Depreciation 7560000 6426000 5462100 4642785 3946367.3
Add: Recovery of net working capital 8800000
Add: After tax salvage value 17585099
Operating cash flows (OCF) (59200000) 35761500 35307900 34922340 34594614 60701146
PV factors @ 15% 1 0.8695652 0.7561437 0.6575162 0.5717532 0.4971767
Present value (59200000) 31096957 26697845 22962005 19779583 30179198
Net Present Value (NPV) 71515587

W.Note

Sale proceeds 14400000
Cost 22362748
Loss -7962748
Tax savings @40% -3185099
After tax salvage value 17585099
WORST CASE
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial cost (33600000)
New Working capital (7200000)
Sales 84787500 84787500 84787500 84787500 84787500
Less- Variable cost 45150000 45150000 45150000 45150000 45150000
Less- Overhead Cost 15000000 15000000 15000000 15000000 15000000
Less- Depreciation 5040000 4284000 3641400 3095190 2630911.5
Earnings before interest and tax 19597500 20353500 20996100 21542310 22006589
Less: Tax @ 40% 7839000 8141400 8398440 8616924 8802635.4
Net Income 11758500 12212100 12597660 12925386 13203953
Add: Depreciation 5040000 4284000 3641400 3095190 2630911.5
Add: Recovery of net working capital 7200000
Add: After tax salvage value 11723399
Operating cash flows (OCF) (40800000) 16798500 16496100 16239060 16020576 34758264
PV factors @ 15% 1 0.8695652 0.7561437 0.6575162 0.5717532 0.4971767
Present value (40800000) 14607391 12473422 10677446 9159816.3 17281000
Net Present Value (NPV) 23399075

W.Note

Sale proceeds 9600000
Cost 14908499
Profit/Loss -5308499
Tax savings @40% -2123399
After tax salvage value 11723399

ekkarill92 answered 1 year ago
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