Question

Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production. You will need an initial $4.3 million 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 $1.025 million and that variable costs should be $190 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 $400,000 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 $410,000. You require a return of 13 percent and face a tax rate of 22 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 +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 your worst-case and best-case scenario 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.) a-1. OCF a-2. NPV b. Worst-case NPV Best-case NPV

Answer 1

Detroit	0	1	2	3	4	5
Investment	-$4,300,000
NWC	-$410,000					$410,000
Salvage						$400,000
Sales		$8,700,000	$8,700,000	$8,700,000	$8,700,000	$8,700,000
VC		-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000
FC		-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000
Depreciation		$860,000	-$860,000	-$860,000	-$860,000	-$860,000
EBT		$1,115,000	$1,115,000	$1,115,000	$1,115,000	$1,115,000
Tax (22%)		-$245,300	-$245,300	-$245,300	-$245,300	-$245,300
Net Income		$869,700	$869,700	$869,700	$869,700	$869,700
Cash Flows	-$4,710,000	$1,729,700	$1,729,700	$1,729,700	$2,139,700	$2,861,700
NPV	$2,239,619.84

Depreciation = Investment / No. of years

OCF = Net Income + Depreciation = 869,700 + 860,000 = 1,729,700

Cash Flows = Investment + NWC + Salvage x (1 - tax) + OCF

NPV can be calculated using the same function in excel or calculated given the cash flows using 13% discount rate.

Worst-case:

Detroit	0	1	2	3	4	5
Investment	-$4,945,000
NWC	-$430,500					$430,500
Salvage						$340,000
Sales		$7,830,000	$7,830,000	$7,830,000	$7,830,000	$7,830,000
VC		-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000
FC		-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000
Depreciation		$989,000	-$989,000	-$989,000	-$989,000	-$989,000
EBT		$116,000	$116,000	$116,000	$116,000	$116,000
Tax (22%)		-$25,520	-$25,520	-$25,520	-$25,520	-$25,520
Net Income		$90,480	$90,480	$90,480	$90,480	$90,480
Cash Flows	-$5,375,500	$1,079,480	$1,079,480	$1,079,480	$1,509,980	$2,205,680
NPV	- $703,429.25

Best case:

Detroit	0	1	2	3	4	5
Investment	-$3,655,000
NWC	-$389,500					$389,500
Salvage						$460,000
Sales		$9,570,000	$9,570,000	$9,570,000	$9,570,000	$9,570,000
VC		-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000	-$5,700,000
FC		-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000	-$1,025,000
Depreciation		$731,000	-$731,000	-$731,000	-$731,000	-$731,000
EBT		$2,114,000	$2,114,000	$2,114,000	$2,114,000	$2,114,000
Tax (22%)		-$465,080	-$465,080	-$465,080	-$465,080	-$465,080
Net Income		$1,648,920	$1,648,920	$1,648,920	$1,648,920	$1,648,920
Cash Flows	-$4,044,500	$2,379,920	$2,379,920	$2,379,920	$2,769,420	$3,517,720
NPV	$5,182,668.92