ACCOUNTING

Consider a project to supply Detroit 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; 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 $500,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $280 per ton. The engineering department estimates you will need an initial net working capital investment of $41 You require a return of 13 percent and face a marginal tax rate of 38 percent on this project. Suppose you believe that the accounting department's initial cost and salvage value projections are accurate only to within +15 percent; the marketing department's price estimate is accurate only to within percent, and the engineering department's net working capital estimate is 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? Suppose you are confident about your own projections, but you are a little unsure about Detroit'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 would not want to operate? Why? Find the accounting, cash, and financial break-even quantities for the company. Find the degree of operating leverage for the company at the base-case output level of 35,000 tons. How does this number compare to the sensitivity figure you found previously? Verify that either approach will give you the same OCF figure at any new quantity level.