Question

Scenario Analysis [L02] 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. What is the estimated OCF for this project? The NPV? Should you pursue this project?

b. Suppose you believe that the accounting department's initial cost and salvage value projections are accurate only to within ±15 percent; the marketing depart-ment'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 for this project? Your best-case scenario? Do scenario for you still want to pursue the project?

Answer 1