In: Finance
North State Manufacturing is considering a contract for a
project to supply Detroit Automotive Solutions with 30,000
tons of machine screws annually for automobile production. North
State Manufacturing will need an initial $4,500,000
investment in threading equipment to get the project started; the
project will last for six years. The accounting
department estimates that annual fixed costs will be $925,000 and
that variable costs should be $280 per ton;
accounting will depreciate the initial fixed asset investment
straight-line to zero over the six-year project life. It also
estimates a salvage value of $500,000 after dismantling costs. The
initial investment and salvage value are accurate
within +/- 8% of the initial projections. The marketing department
estimates that the automakers will approve the
contract at a selling price of $400 per ton. The engineering
department estimates that North State Manufacturing will
need an initial net working capital investment of $500,000, but
management expects to recover their net working
capital in the terminal year of the project. Consider, the units
produced, sales price, variable costs, and fixed costs to
be accurate within +/- 10% of the projections. Also consider, that
the North State Manufacturing is offered a similar
contract with Automoville, Inc. that has an expected net present
value of $850,000, a payback period of 4.2 years, and
IRR of 25%, but it comes with a non-compete clause that will not
allow you to pursue the contract with Detroit
Automotive Solutions. North State Manufacturing requires a return
of 13.75 percent and face a marginal tax rate of
30 percent on this project. You are a Financial Analyst in the
Corporate Finance Division and have been tasked by
North State Manufacturing’s VP-Capital Projects, Cynthia Barlow, to
evaluate this project. The VP would like to
know the following in an executive summary:
What is the base case scenario NPV of the Detroit Automotive
Solutions contract? What is the IRR for the base-case
scenario? What is the payback period for the base-case scenario of
the Detroit Contract?
What is the sensitivity of the project NPV to changes in the
quantity supplied ΔNPV/ΔQ?
What is the sensitivity of the project NPV to changes in the
variable costs ΔNPV/ΔVC?
What is the sensitivity of the project NPV to changes in the fixed
costs ΔNPV/ΔFC?
Which of these items have the greatest impact on the project’s
NPV?
Following are given below :
I. The Best Case Scenario (Unit Price is up 10%, Unit Sales is up 10%, Fixed costs is down 10%, Variable Costs is down 10%)
II. The Sensitivity of NPV to quantity supplied
III. The Sensitivity of NPV to variable costs
IV. The Sensitivity of NPV to fixed costs
Basis
I. Best Case Scenario
NPV = $10,995,596
IRR = 77.58%
PBP = 1.25 years
Revenue forecast | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
Units sold (A) | 33000 | 33000 | 33000 | 33000 | 33000 | 33000 | |
Sales Price / Unit (B) | 440 | 440 | 440 | 440 | 440 | 440 | |
Variable cost/ Unit (C | 252 | 252 | 252 | 252 | 252 | 252 | |
Revenues (D = A x B) | 14,520,000 | 14,520,000 | 14,520,000 | 14,520,000 | 14,520,000 | 14,520,000 | |
Variable costs (E = A x C) | (8,316,000) | (8,316,000) | (8,316,000) | (8,316,000) | (8,316,000) | (8,316,000) | |
Fixed Costs (F) | (832,500) | (832,500) | (832,500) | (832,500) | (832,500) | (832,500) | |
Depreciation (G = (M) /6) | (750,000) | (750,000) | (750,000) | (750,000) | (750,000) | (750,000) | |
EBIT (H = D + E + F + G) | 4,621,500 | 4,621,500 | 4,621,500 | 4,621,500 | 4,621,500 | 4,621,500 | |
Taxes @ 30% (I = H x 30%) | (1,386,450) | (1,386,450) | (1,386,450) | (1,386,450) | (1,386,450) | (1,386,450) | |
Net Income (J = H - I) | 3,235,050 | 3,235,050 | 3,235,050 | 3,235,050 | 3,235,050 | 3,235,050 | |
Depreciation (G) | 750,000 | 750,000 | 750,000 | 750,000 | 750,000 | 750,000 | |
Net Working Capital Investments (K) | (500,000) | ||||||
Return of Net working Capital (L) | 500,000 | ||||||
Capital Expenditure in Plant & Mach(M) | (4,500,000) | ||||||
Salvage Value of Equipment N | 500,000 | ||||||
Tax on Salvaged Equipment O | (150,000) | ||||||
Free Cash Flow (FCF = J+G+K+L+M+N +O) | (5,000,000) | 3,985,050 | 3,985,050 | 3,985,050 | 3,985,050 | 3,985,050 | 4,835,050 |
Cost of Capital (Discount Rate) R | 13.75% | ||||||
PV Of Free Cash Flow | (5,000,000) | 3,503,341 | 3,079,860 | 2,707,569 | 2,380,281 | 2,092,554 | 2,231,992 |
NPV (Sum of PV of all CF) | 10,995,596 | ||||||
IRR | 77.58% | ||||||
PBP | 1.25 |
II. The Sensitivity of NPV to quantity supplied
Sensitivity of Quantity Supplied | |||
Variation in Units | Units Supplied | NPV | % Change in NPV |
-10% | 27,000 | 2,618,323 | -27.4% |
-5% | 28,500 | 3,111,668 | -13.7% |
0% | 30,000 | 3,605,013 | 0.0% |
5% | 31,500 | 4,098,358 | 13.7% |
10% | 33,000 | 4,591,703 | 27.4% |
III. The Sensitivity of NPV to variable costs
Sensitivity of Variable Cost | |||
Variation in Variable Costs | Variable costs | NPV | % Change in NPV |
-10% | 252 | 5,907,290 | 63.9% |
-5% | 266 | 4,756,151 | 31.9% |
0% | 280 | 3,605,013 | 0.0% |
Related SolutionsNorth State Manufacturing is considering a contract for a project to supply Detroit Automotive Solutions with...North State Manufacturing is considering a contract for a
project to supply Detroit Automotive Solutions with 30,000 tons of
machine screws annually for automobile production. North State
Manufacturing will need an initial $4,500,000 investment in
threading equipment to get the project started; the project will
last for six years. The accounting department estimates that annual
fixed costs will be $925,000 and that variable costs should be $280
per tons accounting will depreciate the initial fixed asset
investment straight-line to zero...
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a project to supply Detroit Automotive Solutions with 30,000 tons
of machine screws annually for automobile production. North State
Manufacturing will need an initial $4,500,000 investment in
threading equipment to get the project started; the project will
last for six years. The accounting department estimates that annual
fixed costs will be $925,000 and that variable costs should be $280
per ton; accounting will depreciate the initial fixed asset
investment straight-line to zero...
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started; the project will last for five years. The accounting
department estimates that annual fixed costs will be $750,000 and
that variable costs should be $260 per ton; accounting will
depreciate the initial fixed asset investment straight-line to zero
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investment in threading equipment to get the project started; the
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estimates that annual fixed costs will be $700,000 and that
variable costs should be $200 per ton; accounting will depreciate
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$5,800,000 investment in threading equipment to get the project
started; the project will last for six years. The accounting
department estimates that annual fixed costs will be $700,000 and
that variable costs should be $200 per ton; accounting will
depreciate the initial fixed asset investment straight-line to zero
over the six-year project life. It also estimates a salvage value...
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