Consider a project to supply Detroit with 32,000 tons of machine screws annually for automobile production. You

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Consider a project to supply Detroit with 32,000 tons of machine screws annually for automobile production. You will need an initial $2,350,000 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 $230,000 and that variable costs should be $173 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 $219 per ton. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a return of 13 percent and face a marginal tax rate of 38 percent on this project. 

aWhat is the estimated OCF for this project? The NPV? Should you pursue this project?

bSuppose 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 scenario for this project? Your best-case scenario? Do you still want to pursue the project?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...
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Corporate Finance Core Principles and Applications

ISBN: 978-1259289903

5th edition

Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan

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