Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,600,000 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 $650,000 and that variable costs should be $200 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 $600,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $290 per ton. The engineering department estimates you will need an initial net working capital investment of $260,000. You require a return of 12 percent and face a marginal tax rate of 38 percent on this project. |

Suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. |

a. |
What is the sensitivity of the project OCF to changes in the quantity supplied? |

ΔOCF/ΔQ | $ |

b. |
What is the sensitivity of NPV to changes in quantity supplied? |

ΔNPV/ΔQ | $ |

c. |
Given the sensitivity number you calculated, is there some minimum level of output below which you wouldn’t want to operate? |

Minimum level of output | units |