You work in the Finance Division of a medium size company that is considering a project to supply a customer with 50,000 widgets annually. You will need an initial investment of $4,000,000 in new equipment to get the project started and you estimate that this project will remain active for five years. The Accounting Department estimated $1,000,000 in annual fixed costs and a variable costs of $200 per unit. Additionally, they told you they will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. Additionally, they are expecting a salvage value of $500,000 after dismantling costs. The Marketing Department is confident that they will be able to negotiate a contract with the customer to pay $300 per unit. Finally, the Engineering Department informed that they will need an initial net working capital investment of $350,000. You require a return of 15 percent and face a marginal tax rate of 40 percent on this project. 1. What are the OCF and the NPV for this project? Should you pursue it 2. Suppose you believe that the initial cost and salvage value projections are accurate only to within ±15 percent, the price estimate is accurate only to within ±10 percent; and the net working capital estimate is accurate only to within ±5 percent. -What is your worst-case scenario for this project? - What is your best-case scenario? -Do you still want to pursue the project?

Excel Applications for Accounting Principles

4th Edition

ISBN:9781111581565

Author:Gaylord N. Smith

Publisher:Gaylord N. Smith

Chapter26: Capital Budgeting (capbud)

Section: Chapter Questions

Problem 5R

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You work in the Finance Division of a medium size company that is considering a project to supply a customer with 50,000 widgets annually. You will need an initial investment of $4,000,000 in new equipment to get the project started and you estimate that this project will remain active for five years.

The Accounting Department estimated $1,000,000 in annual fixed costs and a variable costs of $200 per unit. Additionally, they told you they will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. Additionally, they are expecting a salvage value of $500,000 after dismantling costs.

The Marketing Department is confident that they will be able to negotiate a contract with the customer to pay $300 per unit. Finally, the Engineering Department informed that they will need an initial net working capital investment of $350,000.

You require a return of 15 percent and face a marginal tax rate of 40 percent on this project.

1. What are the OCF and the NPV for this project? Should you pursue it

2. Suppose you believe that the initial cost and salvage value projections are accurate only to within ±15 percent, the price estimate is accurate only to within ±10 percent; and the net working capital estimate is accurate only to within ±5 percent.

-What is your worst-case scenario for this project?

- What is your best-case scenario?

-Do you still want to pursue the project?

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