Problem 11-27 Scenario Analysis [LO2] Consider a project to supply Detroit with
ID: 2804796 • Letter: P
Question
Problem 11-27 Scenario Analysis [LO2] Consider a project to supply Detroit with 40,000 tons of machine screws annually for automobile production You will need an initial $5,000,000 investment in threading equipment to get the project started; the project will last for six years. The accounting department estimates that annual fixed costs will be $700,000 and that variable costs should be $300 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the six-year project life. It also estimates a salvage value of $600,000 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 $500,000. You require a return of 15 percent and face a marginal tax rate of 30 percent on this project. a-1 What is the estimated OCF for this project? (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.) OCF $ 1690000 a-2 What is the estimated NPV for this project? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) NPV $ 1370160 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 are your worst-case and best-case NPVs for this project? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Worst-case Best-caseExplanation / Answer
Sales = 40,000 x 370 = 14,800,000
VC = 40,000 x 300 = 12,000,000
Depreciation = Investment / 6 = 5,000,000 / 6 = 833,333
Operating Cash Flows = Net Income + Depreciation = 1,720,000
Terminal Cash Flows = OCF + NWC + Salvage x (1 - tax)
NPV can be calculated using NPV function on a calculator or excel
NPV = $1,407,051.62
Worst-case NPV is when costs are up and price are down.
Investment = 5,750,000, Salvage = 510,000, Price = 333, NWC = 525,000
Worst-case NPV = -3,163,182.80
Best-case NPV is when costs are down and price are up.
Investment = 4,250,000, Salvage = 690,000, Price = 407, NWC = 475,000
Best-case NPV = 5,977,286.04
Detroit 0 1 2 3 4 5 6 Investment -$5,000,000 NWC -$500,000 $500,000 Salvage $600,000 Sales $14,800,000 $14,800,000 $14,800,000 $14,800,000 $14,800,000 $14,800,000 VC -$12,000,000 -$12,000,000 -$12,000,000 -$12,000,000 -$12,000,000 -$12,000,000 FC -$700,000 -$700,000 -$700,000 -$700,000 -$700,000 -$700,000 Depreciation -$833,333 -$833,333 -$833,333 -$833,333 -$833,333 -$833,333 EBT $1,266,667 $1,266,667 $1,266,667 $1,266,667 $1,266,667 $1,266,667 Tax (30%) -$380,000 -$380,000 -$380,000 -$380,000 -$380,000 -$380,000 Net Income $886,667 $886,667 $886,667 $886,667 $886,667 $886,667 Cash Flows -$5,500,000 $1,720,000 $1,720,000 $1,720,000 $1,720,000 $1,720,000 $2,640,000 NPV $1,407,051.62