We are evaluating a project that costs $888,000, has an 12-year life, and has no
ID: 2649116 • Letter: W
Question
We are evaluating a project that costs $888,000, has an 12-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 145,000 units per year. Price per unit is $36, variable cost per unit is $24, and fixed costs are $896,880 per year. The tax rate is 36 percent, and we require a 15 percent return on this project.
Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/-11 percent. The best-case NPV is $ . . . and worst-case NPV is $ . . .
We are evaluating a project that costs $888,000, has an 12-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 145,000 units per year. Price per unit is $36, variable cost per unit is $24, and fixed costs are $896,880 per year. The tax rate is 36 percent, and we require a 15 percent return on this project.
Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/-11 percent. The best-case NPV is $ . . . and worst-case NPV is $ . . .
Explanation / Answer
Answer: We First need to compute depreciation:
D = 888,000 /12 = $74000
To get the base case NPV, first find the OCF:
OCF = (Sales - Costs) x (1 - T) + Depr x T
= (5220,000 - 3480,000 - 896880) x .64+ 74000 x .34
= (843120)*.64+25160
=564756.8
There is no salvage value and no change in NWC. To get NPV, use your calculators with an initial cash flow of -888,000 followed by 12 cash flows of 564756.8 each, and a discount rate of 15%. You should get NPV = $2173331.4396
To get the best case NPV, use P=39.96, Q=160950, VC=21.36, and FC=798223.2.
Repeating the above calculations with these values,
OCF = (Sales - Costs) x (1 - T) + Depr x T
= (160950*39.96 - 160950*21.36 - 798223.3) x .64+ 74000 x .34
= (2195446.7)*.64+25160
=1430245.888
There is no salvage value and no change in NWC. To get NPV, use your calculators with an initial cash flow of -888,000 followed by 12 cash flows of 1430245.888 each, and a discount rate of 15%. You should get NPV = $6864818.033
For the worst case, use P=32.04, Q=129050, VC=26.64, and FC=995536.8.
Repeating the above calculations with these values,
OCF = (Sales - Costs) x (1 - T) + Depr x T
= (129050*32.04 - 129050*26.64 - 995536.8) x .64+ 74000 x .34
= (-298666.8)*.64+25160
=--165986.752
There is no salvage value and no change in NWC. To get NPV, use your calculators with an initial cash flow of -888,000 followed by 12 cash flows of --165986.752 each, and a discount rate of 15%. You should get NPV = -$1787750.94139.
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