We are evaluating a project that costs $660,000, has a five-year life, and has n

Question

We are evaluating a project that costs $660,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 69,000 units per year. Price per unit is $58, variable cost per unit is $38, and fixed costs are $660,000 per year. The tax rate is 35 percent, and we require a 12 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

Explanation / Answer

Here we will use tax shield approach to calculate operating cash fows OCF in both the case.

a. Best Case : Price and quantity increase by 10% and Variable and fixed costs decrease by 10%

OCF = {[(58*1.1)-(38*0.9)] * 69000*1.1

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