Consider a project to supply Detroit with 40,000 tons of machine 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 fixed costs will be $450,000 and that variable costs should be $210 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 $230 per ton. The engineering department estimates you will need an initial working capital investment of $450,000. You will require a 13 percent return and face a marginal tax rate of 38 percent.

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

b. Suppose you believe that the accounting departments initial cost and salvage value projections are accurate only to within 15 percent; the marketing departments price estimate is accurate only to within 10 percent; and the engineering departments net working capital estimate is accurate only to within 15 percent. What is your worst case scenario? your best case scenario? Do you still want to pursue this project? Hint: Assume equal likelihood of occurrence in all possible scenarios.

c. Suppose you are confident about your projections but you are a little unsure about Detroits 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? Is there some minimum level of output below which you wouldnt want to operate? Why?