Reference no: EM132712132

Problem - The Salida Salt Company is considering making a bid to supply the highway department with rock salt to drop on roads in the county during the winter. The contract will guarantee a minimum of 45,000 tons in each year, but the actual quantity may be above that amount if conditions warrant. Management believes that the actual quantity will average 60,000 tons per year. The firm will need an initial $1,400,000 investment in processing equipment to get the project started. The contract will last for five years and is not expected to be renewed. The accounting department has estimated that annual fixed costs will be $350,000 each year and that variable costs should be about $47 per ton of the final product. The new equipment will be depreciated using MACRS with a class life of five years. At the end of the project, it is estimated that the equipment could be sold for $150,000. The marketing department estimates that the state will grant the contract at a selling price of $60 per ton, though it may get some lower bids if the contract is opened for competitive bidding. The engineering department estimates that the project will need an initial net working capital investment of $125,000. The firm's WACC is 10%, and the marginal tax rate is 25%.

Required -

a. Set up a worksheet containing all of the relevant information in this problem, and operating cash flow statement that shows the total annual cash flows for each year, including the initial outlay.

b. Calculate the payback period, discounted payback period, NPV, IRR, and MIRR of this project. Is the project acceptable?

c. If the state decides to open the project for competitive bidding, what is the lowest bid price that you can enter without reducing shareholder wealth? Explain why your answer is correct.

d. Perform a Monte Carlo simulation with 1,000 trials to determine the expected NPV and the standard deviation of the expected NPV. The uncertain variables and their probability distributions are given below. The quantity of rock salt sold should be simulated for each year independently of the others (i.e., it is five separate variables).

Variable	Distribution
Tons of rock salt in each year	Triangular with a minimum of 45,000, most likely of 60,000, and maximum of 95,000.
Variable cost per ton	Normal with a mean of $47 and a standard deviation of $3.
Salvage value of equipment	Uniform with a minimum of $80,000 and a maximum of $200,000.

e. Create a histogram showing the probability distribution of NPV.

f. Using the output of the simulation, what is the probability that the NPV will be less than or equal to zero? Would you suggest that the project be accepted?