Question

You are considering a project that will supply an automobile production facility with 35,000 tonnes of machine screws annually for five years. To get the project started, you will need an initial investment of $1,500,000 in threading equipment. The project will last for five years. The accounting department estimates that annual fixed costs will be $300,000 and that variable costs should be $200 per tonne. The CCA rate for threading equipment is 20%. Accounting estimates a salvage value of $500,000 after costs of dismantling. The marketing department estimates that the auto makers will accept the contract at a selling price of $250 per tonne. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 15% return and face a marginal tax rate of 38% on this project.   

a. What is the NPV for this project? Should you pursue this project?

b. Suppose you believe that the accounting department’s initial cost and salvage projections are accurate only to within ±15%; the marketing department’s price estimate is accurate only to within ±10%; and the engineering department’s net working capital estimate is accurate only to within ±5%. What is your worst-case scenario for this project? Your best-case scenario?

Answer 1

Given information: equipment = 35,000 tonnes Life of $ 300,000 = $200 In alal Lovestorent in threading - $ 1500, oro Production of machine screw per annum project & Syr. Annual fixed cont : Vanable Cost per tonne Selling price Prestimated by = $250 marketing department), CCA rate for threading equipment 2016 Salvage value at end of sith! Tritical Net Working Capital Investment = $450,000 Disc. Rate 15% Marginal Tax Rate = 38% $ 500,000 ya Solution a. NPV of project 1. Present Value of cash outflows (P.V. (O) a. litial Advestorent in threading # 1,500,000 equipment on Day ! b. Initias investment in Net Working & 450,000 Capital on Day ! C. Ca'n Ouellow due to tax on (apital Gain (W143) $24332 $52,960 x 0.4972, consFa @ 15l 5thur) $1,976,332

I. Present Value of Cash Inflows CP.V. (1) feat Operating Cash flows (WHI) Annual Ong Cash flows XPATX (1-tax rate) (@ 15% Sym before tax (WNI) $1,450,00D x 3.3522X0.62 = $4,860,6902082 = $3,013,628 b. Tax saving on Capital Cent Allowance / Depreciation (WM2) = $244,777 c. Release of Working Capital et end of Project life $4,50,000 X 0.4972 = $.223,740. oo Total P. V-I = $3,482,145 II. M.pv. for this project - P. V.CI P.V.co - $3,482, 145 ( $1,976,332 - $ 1,505,813 Since NPV od Project is should punue this project positive, we

Working Mate; 1. Annual Operating cash lows Sales (35000X $ 250 per tonne) 8750,000 les Vanceble Cost (35aur tonnes X (2,000,000) $200 pertonne) Contribution $1,750,000 less Fixed Cont ($ 300.000 Annual Operating Cash Inflows $1,450, ovo before tax. 2. Tax Saving year 1 2 10. on Capital Con Allowance (CCA) CCA Arit & Tax Amt Disc. Present @ CCA Radebol, @381.6 @ 15% Values 1,500,000 x 20%,*$ = 150,000 51,000 18696$49,567 0.500,00-150,000) X 201, -2,70,000 1,080,000x20% - 216,000 864,000 X 20% = 172,800 6, 91,200 X 20% = 138,240 102,600 6.7561 677,576 3 82,080 0.6575 $3,968 4 65,664 10.5718 $37,547 5 52,531 04972 $26, 119 Total PV $244773

1 B. Capital can sell of Threading legg Depreciated Amount at end of sma year $5.52.960 Salvage Valve at end of 5th year $5°00,000 Tax Cube on capital goud on sale of Threading Equipment ak end of life of project re 5th year. Salvage value (-) Depreciated Vale $ 552,960 - $500,000 $ 52,960 2 sale

2 Wome Care Best Care. - $5.75, ao a) Initial Cost of $1.500,000 14 Kl. 1500, angst, Threading & quippost = $11725,000 $1,275,000 b Salvage Value + kl $ 500,000 (415)$900, Oro #3 156, $495,000 (c) Selling Price $250 (-10% $250 Hlol per torine #10% - $225 (d) Sales 3SOVO K 225 = 47,875,00 calce $275 3 SUV X 275 $9625,000 14 (e) Net Working $450,00OCH ST. $472, SUD $450, 145/ = $427,SUD Capital Ist b. N. v. for Wort Carel Best Care Scanany

1. Porrent Value of Cash Out How Prico 21 23/24 25 26 Wont Case Pansculan Best lase, $1,275,000 $427,500 0 Initial Investment in a. Threading Equiprem: 41725,000 b Net Working Capital $ 472,500 © Cash Outflow due to tax on Capital acein (W13) NiL. $ 52,198. NZ ($104,984 X 0.4972) Total P. v.co. $2,197.500 $1,754,698 22 1. Present Value of Cash Inflows. (P. V. (I) Panriculars Wont Care Ben Car 9. Opg cash flows (WNI) (356, soo x 3.3522) 4 1,195,059 $4,832,196 $1,441,500 x 3:3522) $208,060 Saving On Depreciahn $281,494 Ca Release of Working Capital $234927 $212.553 $472,500 X 0.49/2) 421,000 X ouga2) b. Tax (12)

3 Best Case d. Tax saving Parktulars Woot Care due to Capital los on sell of Equr ment $104,86| C$ 210,904 X 0:4972) funs) M2 NIL Total Pv. CI $ 1,816,341 $5252,809 B M.p.v. of Wool Care Scenano of p = $1,816,341 ) $2,197,500 - ($ 381,159) 24 = NPV of Best Case scenano $5.252,809 $ 1.754,698 $ 3,498, 1

V 17 2 Tax Saving in Deprecation. ICCA. since Initical Cost is increased by 15/ in Worm Care &cenano e decreased by lsl in Best Car Scenano. Depreci celom will also get increased (decreased by 151. in wont (best (ure stenario respectively De Tax Saung on Deprecatom to Wost lane scenano $244,777 (A) 15% = $281,494. from panta) b. Best Care Scenano $ 244,777 EMIS) = $ 208,060 (from parta) Saturday 18

19 3. Capital Gain on sell of Threading Woot (are Bet lare 5,52,960 Spalvage Valve (0 $425,000 $575.000 Depreciated Valve $552,960 B 643157 15635,904) $$ 470,016) Capital con Alon) (A-D:($210,904) $ 104,984 20 Monday

Original NPV =$1,505,813

NPV in worst case scenario=($381,159)

NPV in Best Case Scenario=$3,498,111