Academic Integrity: tutoring, explanations, and feedback — we don’t complete graded work or submit on a student’s behalf.

GBK, Inc. is considering a new product. The proposal is as follows: Project cost

ID: 2624236 • 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?

Explanation / Answer

Particulars

Upper Boundary

Lower Boundary

Unit Sales

180*1.10

= 198

180*0.90

= 162

Variable Costs

12400*1.10

= 13640

12400*0.90

= 11160

Fixed costs per year

490000*1.10

= 539000

490000*0.90

= 441000

Particulars

Upper Boundary

Lower Boundary

Sales

(198*20000)

= 3960000

(162*20000)

= 3240000

Less:- Variable cost

(198*12400)

= 2455200

(162*12400)

= 2008800

Less:- Fixed cost

539000

441000

Less:- Depreciation [2,000,000/5]

400000

400000

Profit Before tax

565800

390200

Less:-Taxes @ 35%

198030

136570

Profit after tax

367770

253630

Add:- Depreciation

400000

400000

Net Cash flow

767770

653630

What is the base case NPV?

Base-case Cash flow = [(20000-12400)*180

Particulars

Upper Boundary

Lower Boundary

Unit Sales

180*1.10

= 198

180*0.90

= 162

Variable Costs

12400*1.10

= 13640

12400*0.90

= 11160

Fixed costs per year

490000*1.10

= 539000

490000*0.90

= 441000

Particulars

Upper Boundary

Lower Boundary

Sales

(198*20000)

= 3960000

(162*20000)

= 3240000

Less:- Variable cost

(198*12400)

= 2455200

(162*12400)

= 2008800

Less:- Fixed cost

539000

441000

Less:- Depreciation [2,000,000/5]

400000

400000

Profit Before tax

565800

390200

Less:-Taxes @ 35%

198030

136570

Profit after tax

367770

253630

Add:- Depreciation

400000

400000

Net Cash flow

767770

653630

What is the base case NPV?

Base-case Cash flow = [(20000-12400)*180