Problem 11-27 Scenario Analysis [LO2] Consider a project to supply Detroit with
ID: 2761935 • Letter: P
Question
Problem 11-27 Scenario Analysis [LO2] Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $2,800,000 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 $750,000 and that variable costs should be $260 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 $220,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $370 per ton. The engineering department estimates you will need an initial net working capital investment of $280,000. You require a 14 percent return and face a marginal tax rate of 38 percent on this project. a-1 What is the estimated OCF for this project? OCF $ 1111800 a-2 What is the estimated NPV for this project? (Round your answer to 2 decimal places. (e.g., 32.16)) NPV $ 1102322.65 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 ±5 percent. What is your worst-case and best-case scenario for this project? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) Worst-case $ Best-case $
Explanation / Answer
Solution :
To compute the cash flow of the company :
Step 2: to compute the NPV of the project :
The answer given in the question i beleive is not right :
Formulas 1 2 3 4 5 No of unit sold 20000 20000 20000 20000 20000 Sales = unit *370 7400000 7400000 7400000 7400000 7400000 cost= no of unit *260 5200000 5200000 5200000 5200000 5200000 Gross profit = sales - cost 2200000 2200000 2200000 2200000 2200000 Fixed cost 750000 750000 750000 750000 750000 Depreciation Straight line (Cost - salvage value) / no of years (750000- 220000)/ 5 106000 106000 106000 106000 106000 profit before tax=gross- fixed -dep 1344000 1344000 1344000 1344000 1344000 tax rate 38% 510720 510720 510720 510720 510720 Profit after tax 833280 833280 833280 833280 833280 Cash flow = profit after tax + depreciation 939280 939280 939280 939280 939280