Consider a project to supply Detroit with 40,000 tons of machine screws annually forautomobile production. You will need an initial $5,600,000 investment in threadingequipment to get the project started; the project will last for 6 years. The accountingdepartment estimates that annual fixed costs will be $600,000 and that variable costsshould be $250 per ton. Further, the accounting department will depreciate the initialfixed asset investment straight-line to zero over the 6-year project life and estimate asalvage value of $450,000 after dismantling costs. The marketing department estimatesthat the automakers will let the contract at a selling price of $340 per ton. The engineeringdepartment estimates you will need an initial net working capital investment of $560,000.You require a return of 13 percent and face a marginal tax rate of 24 percent on thisproject.Suppose you’re confident about your own projections, but you’re a little unsure aboutDetroit’s actual machine screw requirements.a. What is the sensitivity of the project OCF to changes in the quantity supplied?b. What about the sensitivity of NPV to changes in quantity supplied?c. Given the sensitivity number you calculated, is there some minimum level ofoutput below which you wouldn’t want to operate?

Friedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.

Caduceus Company is considering the purchase of a new piece of factory equipment that will cost $565,000 and will generate $135,000 per year for 5 years. Calculate the IRR for this piece of equipment. For further instructions on internal rate of return In Excel, see Appendix C.

Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?