Scenario Analysis (L02) Consider a project to supply Thunder Bay with 35,000 tons of machine screws annually for automobile production. You will need an initial $5,200,000 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 $985,000 and that variable costs should be $185 per ton; the CCA rate for threading equipment is 20%. It also estimates a salvage value of $500,000 after dismantling costs. The marketing department estimates a selling price of $280 per ton. The engineering department estimates you will need an initial net working capital investment of $410,000. You require a 13% return and face a marginal tax rate of 38% 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%; the marketing department’s price estimate is accurate only within +10%; and the engineering department’s net working capital estimate is accurate only to within +5%. What is your worst-case scenario for this project? Your best-case scenario? Do you still want to pursue the project? 31
Sensitivity Analysis (L01) In Problem 30, suppose you’re confident about your own projections, but you’re a little unsure about Thunder Bay’s actual machine screw requirement. 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?
