Business

FinanceQ&A LibraryConsider 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?Start your trial now! First week only $4.99!*arrow_forward*

Question

Consider a project to supply Detroit with 40,000 tons of machine screws annually for

automobile production. You will need an initial $5,600,000 investment in threading

equipment to get the project started; the project will last for 6 years. The accounting

department estimates that annual fixed costs will be $600,000 and that variable costs

should be $250 per ton. Further, the accounting department will depreciate the initial

fixed asset investment straight-line to zero over the 6-year project life and estimate a

salvage value of $450,000 after dismantling costs. The marketing department estimates

that the automakers will let the contract at a selling price of $340 per ton. The engineering

department 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 this

project.

Suppose you’re confident about your own projections, but you’re a little unsure about

Detroit’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 of

output below which you wouldn’t want to operate?

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