Reference no: EM132942272

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.

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

Question 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.

Question 3: What is your worst-case scenario for this project?

Question 4: What is your best-case scenario?

Question 5: Do you still want to pursue the project?

Question 6: Suppose you're confident about your own projections, but you're not sure if your customer really needs the 50,000 widgets annually.

Question 7: What is the sensitivity of the project OCF to changes in the quantity supplied?

Question 8: What about the sensitivity of NPV to changes in quantity supplied?

Question 9: Given the sensitivity number you calculated, is there some minimum level of output below which you wouldn't want to operate? Why?