Question

Consider a project to supply Detroit with 26,000 tons of machine screws annually for automobile production. You will need an initial $5,900,000 investment in threading equipment to get the project started; the project will last for 6 years. The accounting department estimates that annual fixed costs will be $1,425,000 and that variable costs should be $270 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the 6-year project life. It also estimates a salvage value of $800,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $386 per ton. The engineering department estimates you will need an initial net working capital investment of $570,000. You require a return of 9 percent and face a tax rate of 21 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 round your answer to 2 decimal places, e.g., 32.16.)

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? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Answer a-1:

Estimated OCF for this project per year = $1,463,390

Workings:

Answer a-2:

NPV of the project = $811,361.73

Workings:

Answer b:

Worst case NPV will be when,  

1. initial cost projection is higher by 5%

2. Salvage value projections is lower by 5%

3. Price will lower by 15%

4. net working capital estimate is higher by 10%

Best case NPV will be when:

1. initial cost projection is lower by 5%.

2. Salvage value projections is higher by 5%

2. Price will higher by 15%

3. Net working capital estimate is lower by 10%

Worst case NPV = - $4,814,126.43

Best case NPV = $6,436,849.89

Workings: