Consider a project to supply Detroit with 35,000 tons of machine screws annually for automobile production....

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Finance

Consider a project to supply Detroit with 35,000 tons of machinescrews annually for automobile production. You will need an initial$2,900,000 investment in threading equipment to get the projectstarted; the project will last for five years. The accountingdepartment estimates that annual fixed costs will be $495,000 andthat variable costs should be $285 per ton; accounting willdepreciate the initial fixed asset investment straight-line to zeroover the five-year project life. It also estimates a salvage valueof $300,000 after dismantling costs. The marketing departmentestimates that the automakers will get the contract at a price of$345 per ton. The engineering department estimates you will need aninitial net working capital investment of $450,000. You require a13 percent return and face a marginal tax rate of 38 percent onthis project.
In Excel
a. What is the estimated operating cash flow for thisproject?(20 points)
b. What is the NPV? Is the project acceptable?(20 points)
c. Suppose you believe that the accounting department’s initialcost and salvage value projections are accurate only to within+/-15 percent; and the engineering department’s net working capitalestimate is accurate only to within +/- 5 percent. What is yourworst case scenario for this project? Your best-case scenario? Doyou still want to pursuit this project?(30 points)
d. Suppose you are confident with your own projections, but youare a little unsure about Detroit’s actual machine screwrequirements. What is the sensitivity of the project OCF to changesin the quantity supplied? What about the sensitivity of NPV tochanges in quantity supplied? Given the sensitivity number youcalculated, is there some minimum level of output below which youwouldn’t want to operate? Why?(30 points)

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4.1 Ratings (522 Votes)

1 Depreciation each year 2900000 5 years 580000 Calculation of annual cash flows Particulars Amount Contract price per unit 345 Varible cost per unit 285 Contribution per unit 60 Total contribution 2100000 60 35000 Less Fixed cost 495000 Depreciation 580000 Profit 1025000 Taxes 38 389500 Net profit after taxes 635500 Add Depreciation 580000 Net cash flows 1215500 Therefore estimated operation cash flows each year 1215500 2 Net Present Value Initial investment 2900000 Working capital investment 450000 which will be reverted back in the terminal year Annual cash flows at present values See Answer

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Transcribed Image Text

Consider a project to supply Detroit with 35,000 tons of machinescrews annually for automobile production. You will need an initial$2,900,000 investment in threading equipment to get the projectstarted; the project will last for five years. The accountingdepartment estimates that annual fixed costs will be $495,000 andthat variable costs should be $285 per ton; accounting willdepreciate the initial fixed asset investment straight-line to zeroover the five-year project life. It also estimates a salvage valueof $300,000 after dismantling costs. The marketing departmentestimates that the automakers will get the contract at a price of$345 per ton. The engineering department estimates you will need aninitial net working capital investment of $450,000. You require a13 percent return and face a marginal tax rate of 38 percent onthis project.*In Excel*a. What is the estimated operating cash flow for thisproject?(20 points)b. What is the NPV? Is the project acceptable?(20 points)c. Suppose you believe that the accounting department’s initialcost and salvage value projections are accurate only to within+/-15 percent; and the engineering department’s net working capitalestimate is accurate only to within +/- 5 percent. What is yourworst case scenario for this project? Your best-case scenario? Doyou still want to pursuit this project?(30 points)d. Suppose you are confident with your own projections, but youare a little unsure about Detroit’s actual machine screwrequirements. What is the sensitivity of the project OCF to changesin the quantity supplied? What about the sensitivity of NPV tochanges in quantity supplied? Given the sensitivity number youcalculated, is there some minimum level of output below which youwouldn’t want to operate? Why?(30 points)