3. 27.

Scenario analysis [LO 11.2] Consider a project to supply Melbourne with 30 000 tonnes of machine screws annually for car production. You will need an initial $4.3 million 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 $1.025 million and that variable costs should be $190 per tonne; accounting will depreciate the initial non-current asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of

$400 000 after dismantling costs. The marketing department estimates that the car manufacturers will let the contract at a selling price of

$290 per tonne. The engineering department estimates you will need an initial net working capital investment of $410 000. You require a return of 13 per cent and face a tax rate of 30 per cent on this project.

1. What is the estimated OCF for this project? The NPV? Should you pursue this project?

2. Suppose you believe that the accounting department’s initial cost and salvage value projections are accurate only to within ±15 per cent; the marketing department’s price estimate is accurate only to within ±10 per cent; and the engineering department’s net working capital estimate is accurate only to within ±5 per cent.

What is your worst-case scenario for this project? Your best-case scenario? Do you still want to pursue the project?