Scenario Analysis Consider a project to supply Detroit with 35,000 tons of machine screws

QUESTION

1.Scenario Analysis Consider a project to supply Detroit with 35,000 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 $495,000 and that variable costs should be $285 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 $300,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $345 per ton. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 13 percent return and face a marginal tax rate of 38 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 departments initial cost and salvage value projections are accurate only to within 615 percent; the marketing departments price estimate is accurate only to within 610 percent; and the engineering departments net working capital estimate is accurate only to within 65 percent. What is your worst-case scenario for this project? Your best-case scenario? Do you still want to pursue the project?2.Sensitivity Analysis In Problem 26, suppose youre confident about your own projections, but youre a little unsure about Detroits 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 wouldnt want to operate? Why?3.Abandonment Decisions Consider the following project for Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $8 million that will be depreciated straight-line to zero over the projects life. An initial investment in networking capital of $950,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $6.85 million in pretax revenues with $2.8 million in total pretax operating costs. The tax rate is 38 percent, and the discount rate is 16 percent. The market value of the equipment over the life of the project is as follows:YearMarket Value ($ millions)1$5.123.833.240.0a. Assuming Hand Clapper operates this project for four years, what is the NPV?b. Now compute the project NPVs assuming the project is abandoned after only one year, after two years, and after three years. What economic life for this proj- ect maximizes its value to the firm? What does this problem tell you about not considering abandonment possibilities when evaluating projects?4.Abandonment Decisions M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video game that requires a $7 million initial investment. M.V.P. expects a total annual operating cash flow of $1.3 million for the next 10 years. The relevant discount rate is 10 percent. Cash flows occur at year-end.a.What is the NPV of the new video game?b.After one year, the estimate of remaining annual cash flows will be revised either upward to $2.2 million or downward to $285,000. Each revision has an equal probability of occurring. At that time, the video game project can be sold for $2.6 million. What is the revised NPV given that the firm can abandon the project after one year?5. Financial Break-even The Cornchopper Company is considering the purchase of a new harvester. Cornchopper has hired you to determine the break-even purchase price in terms of present value of the harvester. This break-even purchase price is the price at which the projects NPV is zero. Base your analysis on the following facts:The new harvester is not expected to affect revenues, but pretax operating expenses will be reduced by $13,000 per year for 10 years.The old harvester is now 5 years old, with 10 years of its scheduled life remaining. It was originally purchased for $65,000 and has been depreciated by the straight-line method.The old harvester can be sold for $21,000 today.The new harvester will be depreciated by the straight-line method over its 10-year life.The corporate tax rate is 34 percent.The firms required rate of return is 15 percent.The initial investment, the proceeds from selling the old harvester, and any resulting tax effects occur immediately.All other cash flows occur at year-end.The market value of each harvester at the end of its economic life is zero.i need them with full formulas and everything as its holds 150 marks for my exams.

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