Question

Consider a project to supply Detroit with 31,000 tons of machine screws annually for automobile production. You will need an initial $6,200,000 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 $1,500,000 and that variable costs should be $285 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 $875,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $404 per ton. The engineering department estimates you will need an initial networking capital investment of $600,000. 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. What is the estimated NPV for this project? (Do not round intermediate calculations 2. 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 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.) a-1. OCF a-2. NPV Worst-case NPV Best-case NPV

Answer 1

a-1. OCF - Operating Cash Flow

		Y0	Y1	Y2	Y3	Y4	Y5
1	Sales Revenue (31000*404)		$ 1,25,24,000	$ 1,25,24,000	$ 1,25,24,000	$ 1,25,24,000	$ 1,25,24,000
2	Operating Cost (Fixed + Variable = 1500000+(285*31000))		$ 1,03,35,000	$ 1,03,35,000	$ 1,03,35,000	$ 1,03,35,000	$ 1,03,35,000
3	Depreciation (6200000/5)		$     12,40,000	$     12,40,000	$     12,40,000	$     12,40,000	$     12,40,000
4	Income before tax		$       9,49,000	$       9,49,000	$       9,49,000	$       9,49,000	$       9,49,000
5	Tax @ 24%		$       2,27,760	$       2,27,760	$       2,27,760	$       2,27,760	$       2,27,760
6	Net income after tax (4-5)		$       7,21,240	$       7,21,240	$       7,21,240	$       7,21,240	$       7,21,240
7	Operating Cash Flow (1-2-5)		$     19,61,240	$     19,61,240	$     19,61,240	$     19,61,240	$     19,61,240

a-2.

NPV = PV(Y0) + PV (Y1) + PV (Y2) + PV (Y3) + PV (Y4) + PV (Y5)

Cost of Capital = 13%

		Y0	Y1	Y2	Y3	Y4	Y5
1	Sales Revenue (31000*404)		$    1,25,24,000	$    1,25,24,000	$    1,25,24,000	$    1,25,24,000	$    1,25,24,000
2	Operating Cost (Fixed + Variable = 1500000+(285*31000))		$    1,03,35,000	$    1,03,35,000	$    1,03,35,000	$    1,03,35,000	$    1,03,35,000
3	Depreciation (6200000/5)		$       12,40,000	$       12,40,000	$       12,40,000	$       12,40,000	$       12,40,000
4	Income before tax		$          9,49,000	$          9,49,000	$          9,49,000	$          9,49,000	$          9,49,000
5	Tax @ 24%		$          2,27,760	$          2,27,760	$          2,27,760	$          2,27,760	$          2,27,760
6	Net income after tax (4-5)		$          7,21,240	$          7,21,240	$          7,21,240	$          7,21,240	$          7,21,240
7	Operating Cash Flow (1-2-5)		$       19,61,240	$       19,61,240	$       19,61,240	$       19,61,240	$       19,61,240
8	Initial Investment *	$      -62,00,000					$          6,65,000
9	Change in net working capital	$        -6,00,000					$          6,00,000
10	Total Cash Flow	$      -68,00,000	$       19,61,240	$       19,61,240	$       19,61,240	$       19,61,240	$       32,26,240
	NPV =	PV(Y0) + PV (Y1) + PV (Y2) + PV (Y3) + PV (Y4) + PV (Y5)
	Cost of Capital	13%
	PV	$      -68,00,000	$ 17,35,610.62	$ 15,35,938.60	$ 13,59,237.70	$ 12,02,865.22	$ 17,51,073.82
	NPV	$          7,84,726

Salvage Value = 875000-(875000*0.24)