Sensitivity Analysis Consider a project to supply Italy with 40,000 tons of machine screws annually for automobile production. You will need an initial

€1,500,000 investment in threading equipment to get the project started; the project will last for 5 years. The accounting department estimates that annual fixed costs will be €600,000 and that variable costs should be €210 per ton; accounting will depreciate the initial fixed asset investment using 20 per cent reducing-balance method over the five-year project life. It also estimates a salvage value of €800,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of €230 per ton. The engineering department estimates you will need an initial net working capital investment of €450,000. You require a 13 per cent return and face a marginal tax rate of 32 per cent on this project.

(a) Suppose you are confident about your own projections, but you are a little unsure about Italy’s actual machine screw requirement. 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 would not want to operate? Why?