Problem:
Scenario Analysis
Consider a project to supply Detroit with 55,000 tons of machines screws annually for automobile production. You will need an initial $1,700,000 investment in threading equipment to get the project started. The project will last for 5 years.
The accounting department estimates that annual fix cost will be $520,000 and that variable costs should be $220 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 $300,000 after dismantling costs.
The marketing department estimates that the auto makers will let the contract at a selling price of $245 per ton. The engineering department estimates you will need an initial net working capital investment of 600,000. You require a 13 percent return and a face a marginal tax rate of 30 percent in this project.
- What is the estimated OCF for this project? The NPV? Should you pursue this project?
- Suppose you believe that the accounting department's initial cost and salvage projection are accurate only to within +/- 15 percent; the marketing department price estimate is accurate to within +/- 10 percent; and the engineering department's net working capital estimate is only 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
Scenario Analysis
Students will read the scenario and then prepare a 3-4 page analysis that addresses the following:
- Calculate the estimated operating cash flow and net present value for this project.
- Explain how these calculations may impact the project.
- Based on the above information, recommend whether or not the project should be pursued. Provide a detailed rationale.
- Suppose you believe that the accounting department's initial cost and salvage value projections are accurate only to within + or - 15%; the marketing department's price estimate is accurate only to within + or - 10%; and the engineering department's net working capital estimate is accurate only to within + or - 5%. Discuss the best and worst case scenarios for this project.
- Based on the above information, recommend whether or not to pursue the project. Provide a detailed rationale.
Additional Information:
The assignment in finance is related to the cash flow and net present value. This is a case study regarding Detroit, a screw manufacturing company. The company is planning to invest on threading equipment and it desires to know how much of cash flow and net present value can be expected from this move. The company also desires to know the best, normal and worst case scenarios from this investment. All these have been computed in MS Excel sheet and stated in a document.