GBK, Inc. is considering a new product. The proposal is as follows: Project cost
ID: 2624182 • Letter: G
Question
GBK, Inc. is considering a new product. The proposal is as follows:
Project cost: $2,000,000
Project life: 5 yrs
Salvage value: zero
Depreciation: straight line to zero
Sales projection: 180 units per year
Price per unit: $20,000
Variable cost per unit will be: $12,400
Fixed costs per year: $490,000
Required return on the project: 10%
Relevant tax rate: 35%
Based on our past experience, the unit sales, variable costs and fixed cost projections are probably accurate to within plus or minus 10%
A] What are the upper and lower bounds for these projections?
B] What is the base case NPV?
C] What are the best case and the worst case scenarios?
D] Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
E] What is the cash break-even level of output for this project (ignoring taxes)?
F] What is the accounting break-even level of output for this project? What is the degree of operating leverage at the accounting break-even point? How do you interpret this number?
Explanation / Answer
Given:
Sensitivity to changes in FC:
Project Cost $ 2,000,000 Life (yrs) 5 Salvage - Depreciation per year $400,000 Sales per year (nos) 180 Unit prices $20,000 VC per unit $12,400 FC per year $490,000 Return 10% Tax 35% Base Worst Case Best Case Sales per year (nos) 180 162 198 Unit price 20,000 20,000 20,000 Sales 3,600,000 3,240,000 3,960,000 VC per unit 12,400 13,640 11,160 Total Variable Cost 2,232,000 2,209,680 2,209,680 FC 490,000 539,000 441,000 Depreciation 400,000 400,000 400,000 NPV 478,000 91,320 909,320 Taxes 167,300 31,962 318,262 Profit after taxes 310,700 59,358 591,058 Tax per unit $929 Cash break even 64.5, so 65 units (Fixed Cost/(sale price - VC) Accounting break-even 73.5, so 74 units (Assuming tax per unit sold as $929)Related Questions
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