Question

Consider a project to supply Detroit with 28,000 tons of machine screws annually for automobile production. You will need an initial $5,200,000 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 $1,250,000 and that variable costs should be $235 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 $625,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $344 per ton. The engineering department estimates you will need an initial net working capital investment of $500,000. You require a return of 13 percent and face a tax rate of 24 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 ±10 percent; and the engineering department’s net working capital estimate is accurate only to within ±15 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

Sales units Contribu Variable tion per cost unit Sale price Depreciatio Year Fixed costs PBT Tax@24% PAT 1 28,000 $ 344 $ 2 28,000 $ 344 $ 3 28,000 $ 344 $ 4 28,000$ 344$ 5 28,000$ 344 $ 235 $ 235 $ 235 $ 235 $ 235 $ 109 109 109 109 109 1,250,000 1,250,000 1,250,000 1,250,000 1,250,000 1,040,000 1,040,000 1,040,000 1,040,000 1,040,000 762,000 762,000 762,000 762,000 762,000 182,880 182,880 182,880 182,880 182,880 579,120 579,120 579,120 579,120 579,120 Net Depreciati Operating working on cash flows capital (500,000) 1,040,000 1,619,120 1,040,000 1,619,120 1,040,000 1,619,120 1,040,000 1,619,120 1,040,000 1,619,120 500,000 Total cash PVIF@ Investment flows 13% Present value (5,200,000) (5,700,000) 1.000 $ (5,700,000.00) 1,619,120 0.885 $ 1,432,849.56 1,619,120 0.783 $ 1,268,008.46 1,619,120 0.693 $ 1,122,131.38 1,619,120 0.613 $ 993,036.62 475,000 2,594,120 0.543 $ 1,407,984.41 Net present value $ 524,010.42 Asset cost Less: Depreciation charged WDV of machine at the time of sale Sale value of machine Profit/(Loss) on sale Less:Tax@24% After tax cash flows from sale of asset $ 5,200,000 $ 5,200,000 $ $ 625,000 $ 625,000 $ 150,000 $ 475,000

Sales units Sale price Contribu Variable tion per cost unit Depreciatio Year Fixed costs 1 28,000 $ 310 2 28,000 $ 310 3 28,000 $ 310 4 28,000 $ 310 5 28,000 $ 310 $ $ $ $ $ 235 $ 235 $ 235 $ 235 $ 235 $ 75 1,250,000 75 1,250,000 75 1,250,000 75 1,250,000 751,250,000 1,092,000 1,092,000 1,092,000 1,092,000 1,092,000 Net Depreciati Operating working Total cash PVIF@ PBT Tax@24% PAT on cash flows capital Investment flows 13% Present value (575,000) (5,460,000) (6,035,000) 1.000 $ (6,035,000.00) (253,200) (60,768) (192,432) 1,092,000 899,568 899,568 0.885 $ 796,077.88 (253,200)| (60,768) (192,432) 1,092,000 899,568 899,568 0.783 $ 704,493.70 (253,200) (60,768) (192,432) 1,092,000 899,568 899,568 0.693 $ 623,445.75 (253,200)| (60,768) (192,432) 1,092,000 899,568 899,568 0.613 $ 551,721.90 (253,200) (60,768) (192,432) 1,092,000 899,568 575,000 451,250 1,925,818 0.543 $ 1,045,256.85 Worst Net present value $ (2,314,003.92) Asset cost Less: Depreciation charged WDV of machine at the time of sale Sale value of machine Profit/(Loss) on sale Less:Tax@24% After tax cash flows from sale of asset $ 5,460,000 $ 5,460,000 $ $ 593,750 $ 593,750 $ 142,500 $ 451,250

Sales units Sale price Contribu Variable tion per cost unit Depreciatio Year Fixed costs 1 28,000 $ 378 $ 2 28,000 $ 378 $ 3 28,000 $ 378 $ 4 28,000 $ 378 $ 5 28,000$ 378 $ 235 $ 235 $ 235 $ 235 $ 235 $ 143 143 143 143 143 1,250,000 1,250,000 1,250,000 1,250,000 1,250,000 988,000 988,000 988,000 988,000 988,000 Net Depreciati Operating working Total cash PVIF@ PBT Tax@24% PAT on cash flows capital Investment flows 13% Present value (425,000) (4,940,000) (5,365,000) 1.000 $ (5,365,000.00) 1,777,200 426,528 1,350,672 988,000 2,338,672 2,338,672 0.885 $ 2,069,621.24 1,777,200 426,528 1,350,672 988,000 2,338,672 2,338,672 0.783 $ 1,831,523.22 1,777,200 426,528 1,350,672 988,000 2,338,672 2,338,672 0.693 $ 1,620,817.01 1,777,200 426,528 1,350,672 988,000 2,338,672 2,338,672 0.613 $ 1,434,351.34 1,777,200 426,528 1,350,672 988,000 2,338,672 425,000 498,750 3,262,422 0.543 $ 1,770,711.96 Best Net present value $ 3,362,024.76 $ 4,940,000 $ 4,940,000 $ Asset cost Less: Depreciation charged WDV of machine at the time of sale Sale value of machine Profit/(Loss) on sale Less:Tax@24% After tax cash flows from sale of asset $ 656,250 $ 656,250 $ 157,500 $ 498,750 a-1) $ a-2) $ b) $ 1,619,120.00 524,010.42 -$2,314,003.92 3,362,024.76

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