Question

Consider a project to supply Detroit with 27,000 tons of machine screws annually for automobile production. You will need an initial $4,700,000 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 $1,125,000 and that variable costs should be $210 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 $500,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $314 per ton. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a return of 13 percent and face a tax rate of 24 percent on this project.

a1. What is the estimated OCF for this project?

a2. What is the estimated NPV for this project?

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 ±15 percent; and the engineering department’s net working capital estimate is accurate only to within ±10 percent. What are your worst-case and best-case NPVs for this project?

Answer 1