Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production. You will need an initial $1,700,000 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 $450,000 and that variable cost should be $210 per ton; account will depreciate the initial fixed asset investment straight line to zero over the five year project life. It also estimates a salvage value of $500,000 after dismanatling costs. The marketing department estimates that the automakers will let the contract at a selling price of $230 per ton. The engineering department estimates you will need an initial working capital investment of $450,000. You will require a 13 percent return and face a marginal tax rate of 38 percent.

1. What is the estimated OCF for this project? The NPV? Should ou pursue this project?

2. Suppose you believe that the accounting department's initial cost and salvage value projections are accurate only to within $\pm$ 15 percent; the marketing department's price estimate is accurate only to within $\pm$ 10 percent; and the engineering department's net working capital estimate is accurate only to with $\pm$ 15 percent. What is your worst case scenario? What is your best case scenario? Do you still want to pursue this project? (Assuming there is an equal likelihood of occurrences in all possible scenarios.)

3. Suppose you are confident about your projections but you are a little unsure about Detroit's actual machine screw requirement. What is the sensitivity of the project OCF to changes in the quantity supplied? Is there some minimum level of output below which you would not want to operate and if so; why?

Answer 1

160000 depre ciation 17 -340,00 Pereay expendi ture$u50 000 Fixed Salvage value - 500, 000 dapreciafed The entire value Simce we be pais mecdeap of Salvage affer tan S00 (1-0.38) asset tax alve $310 000 A ANG Gemiribution fon- S.p- V.C a30-210 Feaoo20 per tn CalCalation of operating ah flow- 9e2ovG Ceniribution TOtal vo,000 x20 800 000 less Tixed enpendi-fure 4so o00 Depreciation 340 000 1/7 $ 10,000 less: Tan 38. 3800 విం depre cintion Adot 340 000 operatiug Cash flow per y $346200

Cal. of N.p.v 03 Tflow 1100, 000 Inibia OUT HInitias workingdapitl 21S0000 alu Inflows melwtiy value of Present value Selvoge o perating Cath flow 346200 PVIF A (Y131. n 3.5112 Present value f caph flows - 1211 6Sy .64 ao0t 31000 e f41249155 present value o Cafh lows ..TO Tay 0dd ao? 12 11654 64 t M12497 55 $1630152.17 N.P.V- 163015a-19 2150000 -$19841.8 0078 Npv is negative t ireCommenly Since ONS net To Parue

case np.v wor st Inital Gt Increases TO $1955000 e $391000 Apnddepreciatin Salvage value decrea ses is f So0000-15 4a5 000 5Lo = de creases bd Seling price :. onTributin 30 (o.9) -2lo -3 parafing Cagh thow Contri butian -120 000 TOTal Certs Fineed 391000 dipeciation (96/000) ors TOTal Los ciation of) ipre Addl 39(000 (ST0 000 Cal 0t NPV o (I-S)-510 DOO ( IFA +[usoon (HS)+ as ovo (-0-3 R(13) - 450 000 NPV wrST -1955000 13 1 ,5 Np.V 4053 409 woTst Case 95

Rest case NPV decreaseg IS Ini i Hial Cott 1y5,00 1445000 dep 289 o00 Solvage value S00000 415. 6SE Price 1 by loy 3eling Con'iribution = Go Cl1) - 910 230 43 Cagh flow:- pevating Centribution =$ 1120000 TOTal GaTS Fined 4J0000 Cess: dipre ciation 389 000 TOTC Pofit 981000 361 312 780 $ 608220 Add:dapreciatios 289 000 $ 891220

N°P.v of Cal us0 000 C0.85)+ 891220 (PUIFA 131,5) -1445000 CI13)5 Rest Case NPV -$1,724,329 82 Sales :- Breal even Break even N.p.V O at cash ows ghould vahue of Preciont be 2I50000 41 2497 SS $ 131502.5 1131 S02.45 Peranmum- A3.S112 0.C-F ShoyK be 19.10016h $ husop Ra D-6M Yeverse 494001-61-340000 2483 89-79 (Before 11 4dd dap and Tixed Erp. l03 8389 7M 10 38389 74 . Rreak even units 20 S1920 tons DMider T rale even Dezoit ghapd Sey Below hy level he s met vi able for 13. return S1920 0ns Pojef