You are considering a new product launch. The project will cost $1,006,000, have

Question

You are considering a new product launch. The project will cost $1,006,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 360 units per year; price per unit will be $19,800, variable cost per unit will be $16,300, and fixed costs will be $334,000 per year. The required return on the project is 14 percent, and the relevant tax rate is 40 percent.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within

Explanation / Answer

c> Particulars/Year 0 1 2 3 4 Initial Investment (A) -100600 Income=Q*(SP-VC)-FC=360*(19800-16300)-334000(B) 926000 926000 926000 926000 Depriciation=100600/4 (C) 25150 25150 25150 25150 Profit after depriciation and tax=(1-0.4)*(B-C) = D 540510 540510 540510 540510 OCF=A+C+D -100600 565660 565660 565660 565660 Present Value @14% -100600 496193 435257 381804.4 334916.1 NPV=Sum of PV 1547571 When SP,VC and FC increase by 10% Particulars/Year 0 1 2 3 4 Initial Investment (A) -100600 Income=Q*(SP-VC)-FC=360*(19800-16300)*1.10-334000*1.10(B) 1018600 1018600 1018600 1018600 Depriciation=100600/4 (C) 25150 25150 25150 25150 Profit after depriciation and tax=(1-0.4)*(B-C) = D 596070 596070 596070 596070 OCF=A+C+D -100600 621220 621220 621220 621220 Present Value @14% -100600 544929.8 478008.6 419305.8 367812.1 NPV=Sum of PV 1709456 When SP,VC and FC decrease by 10% Particulars/Year 0 1 2 3 4 Initial Investment (A) -100600 Income=Q*(SP-VC)-FC=360*(19800-16300)*0.9-334000*0.9(B) 833400 833400 833400 833400 Depriciation=100600/4 (C) 25150 25150 25150 25150 Profit after depriciation and tax=(1-0.4)*(B-C) = D 484950 484950 484950 484950 OCF=A+C+D -100600 510100 510100 510100 510100 Present Value @14% -100600 447456.1 392505.4 344303 302020.1 NPV=Sum of PV 1385685 The best case OCF/NPV is at a time when SP,VC and FC increase by 10% d> When FC=344000 Particulars/Year 0 1 2 3 4 Initial Investment (A) -100600 Income=Q*(SP-VC)-FC=360*(19800-16300)-344000(B) 916000 916000 916000 916000 Depriciation=100600/4 (C) 25150 25150 25150 25150 Profit after depriciation and tax=(1-0.4)*(B-C) = D 534510 534510 534510 534510 OCF=A+C+D -100600 559660 559660 559660 559660 Present Value @14% -100600 490929.8 430640.2 377754.6 331363.6 NPV=Sum of PV 1530088 e>When FC=334001 Particulars/Year 0 1 2 3 4 Initial Investment (A) -100600 Income=Q*(SP-VC)-FC=360*(19800-16300)-334001(B) 925999 925999 925999 925999 Depriciation=100600/4 (C) 25150 25150 25150 25150 Profit after depriciation and tax=(1-0.4)*(B-C) = D 540509.4 540509.4 540509.4 540509.4 OCF=A+C+D -100600 565659.4 565659.4 565659.4 565659.4 Present Value @14% -100600 496192.5 435256.5 381804 334915.8 NPV=Sum of PV 1547569 So sensitivity=Change in NPV to change in FC =1547571-1547569=2

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