We are evaluating a project that costs $836,000. Has an eight-year life and has

Question

We are evaluating a project that costs $836,000. Has an eight-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 93,000 units per year. Price per unit is $43, a variable cost per unit is $28, and fixed costs are $945,000 per year. The tax rate is 35 percent, and we require a return of 15 percent on project.

In the previous problem. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within + 10 percent. Calculate the best case and worst-case NPV figures.

Explanation / Answer

Accounting Break -Even

B)First find the operating Cash flow

Sales 93000 @ 43 =3999000

Less Variable Cost93000*28=2604000

Fixed cost 945000 =3549000

Cash flow =450000 (1-taxrate ie 0.35)=292500

AddTax savings due to depn =104500(0.35) =36575

Total Cash flows /yr will be 329075

Finding Net Present Value for this project

Initial investment -836000*1.000= -836000

Yrly cash inflow +329075*4.487=+1476560 (inflows for 8 yrs.@15% --PV factor as per PV of 1 per period)

Sensitivity to change in sales figure Say,93100units

Sales =4003300

Less VC 2606800

FC 945000 =3551800

Cash flow 451500 *0.65=293475

Add Depn 104500 *0.35=36575

Total yrly. cash flow 330050

REvised NPV

-836000 + 330050*4.487=644934

Increase in NPV=644934-640560= 4374 this is for 100 units of increase in sales

So per unit sensitivity==4374/100=43.74

Sensitivity of OCF to $1 decrease in VC

Sales =3999000

LessVC 93000*27 2511000

FC 945000 =3456000

Contribution =543000 @0.65=352950

Add Depn =104500@0.35=36575

Total OCF =389525

Sensitivity of OCF to $1 DECREASE in VC is 389525-329075=$ 60450 -INCREASED Cash flow

Decrease in VC increases annual cash flow and also will give a better NPV

Answer to (d) not attempted as it will involve two sets of all the above calculations- Can be done as a separate

question

Sales /unit 43 Less Variable Cost /unit 28 Contribution /unit 15 Fixed cost + Depreciation 945000+ (836000/8) 1049500 Accounting Break -even 1049500/15 69967units

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