6) Consider a project to supply Detroit with 25,000 tons of machine screws annua

Question

6) Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,600,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $650,000 and that variable costs should be $200 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $600,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project. a-1 What is the estimated OCF for this project? (Do not round intermediate calculations.) a-2 What is the estimated NPV for this project? (Do not round intermediate calculations. 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 ±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? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Answer:a Using the tax shield approach, the OCF is:

OCF = [($290 – 200)(25,000) – $650,000](0.62) + 0.38($2,600,000/5)

OCF =$992000+$197600

=$1189600

Answer:a-2 NPV= –$2,600,000 – 260,000 + $1,189,600(PVIFA12%,5) + [$260,000 + $600,000(1 – .38)]/1.125

NPV= $1,786,855.54

Answer:b In the worst-case, the OCF is:

OCFworst= {[($290)(0.90) – 200](25,000) – $650,000}(0.62) + 0.38[$2,600,000(1.15)/5]

OCFworst= $542500+227240

=$769740

And the worst-case NPV is:

NPVworst= –$2,600,000(1.15) – $260,000(1.05) + $769740(PVIFA12%,5) + [$260,000(1.05) +$600,000(0.85)(1 – 0.38)]/1.125

NPVworst= –$153931.66

The best-case OCF is:

OCFbest= {[$290(1.10) – 200](25,000) – $650,000}(0.62) + 0.38[$2,600,000(0.85)/5]

OCFbest= 1441500+167960

=1609460

And the best-case NPV is:

NPVbest= –$2,600,000(0.85) – $260,000(0.95) + $1609460(PVIFA12%,6) + [$260,000(0.95) +$600,000(1.15)(1 – 0.38)]/1.125

NPVbest= $3,727,642.75

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