26. Scenario Analysis Consider a project to supply Detroit with 26,000 tons of machine screws annually for automobile production. You will need an initial $2,900,000 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 $345,000 and that variable costs should be $295 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 $275,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $375 per ton. The engineering department estimates you will need an initial net working capital investment of $500,000. You require a 13 percent return and face a marginal tax rate of 24 percent on this project. a. What is the estimated OCF for this project? The NPV? Should you pursue this project? 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 scenario for this project? Your best-case scenario? Do you still want to pursue the project? 27. Sensitivity Analysis In e Problem 26, suppose you're confident about your own projections, but you're a little unsure about Detroit's actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity of NPV to changes in quantity supplied? Given the sensitivity number you calculated, is there some minimum level of output below which you wouldn't want to operate? Why?
26. Scenario Analysis Consider a project to supply Detroit with 26,000 tons of machine screws annually for automobile production. You will need an initial $2,900,000 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 $345,000 and that variable costs should be $295 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 $275,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $375 per ton. The engineering department estimates you will need an initial net working capital investment of $500,000. You require a 13 percent return and face a marginal tax rate of 24 percent on this project. a. What is the estimated OCF for this project? The NPV? Should you pursue this project? 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 scenario for this project? Your best-case scenario? Do you still want to pursue the project? 27. Sensitivity Analysis In e Problem 26, suppose you're confident about your own projections, but you're a little unsure about Detroit's actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity of NPV to changes in quantity supplied? Given the sensitivity number you calculated, is there some minimum level of output below which you wouldn't want to operate? Why?
Cornerstones of Cost Management (Cornerstones Series)
4th Edition
ISBN:9781305970663
Author:Don R. Hansen, Maryanne M. Mowen
Publisher:Don R. Hansen, Maryanne M. Mowen
Chapter19: Capital Investment
Section: Chapter Questions
Problem 10E: Roberts Company is considering an investment in equipment that is capable of producing more...
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Question 27 is the question I need help with.
Transcribed Image Text:26. Scenario Analysis Consider a project to supply Detroit with 26,000 tons of machine screws annually for automobile production. You
will need an initial $2,900,000 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 $345,000 and that variable costs should be $295 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
$275,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of
$375 per ton. The engineering department estimates you will need an initial net working capital investment of $500,000. You require a
13 percent return and face a marginal tax rate of 24 percent on this project.
a. What is the estimated OCF for this project? The NPV? Should you pursue this project?
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 scenario for this project? Your best-case
scenario? Do you still want to pursue the project?
Transcribed Image Text:27. Sensitivity Analysis In e Problem 26, suppose you're confident about your own projections, but you're a little unsure about Detroit's
actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the
sensitivity of NPV to changes in quantity supplied? Given the sensitivity number you calculated, is there some minimum level of output
below which you wouldn't want to operate? Why?
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