We are evaluating a project that costs $768,000, has a six-year life, and has no
ID: 2653059 • Letter: W
Question
We are evaluating a project that costs $768,000, has a six-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 57,000 units per year. Price per unit is $60, variable cost per unit is $35, and fixed costs are $770,000 per year. The tax rate is 35 percent, and we require a return of 15 percent on this project. 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
Solution:
Computation of Best Case NPV
Price per unit = $ 60 + 10 % = $ 66/ unit
Variable Cost per unit = $ 31.5 per unit
Sales = 62,700
Fixed Cost = $ 693,000
Required Rate of Return = 15 %
NPV (best case) = Present Value of cashflows - Initial Outflow
= (( Sales - Total cost) ( 1 - tax rate) + Depreciation * Present Value factor @ 15 %) - Initial Outflow
= (Operating Cashflows * PVAF @ 15 %) - $768,000
= ( $ 66*62,700 -$ 31,5 * 62,700 - $ 693,000 + ($768,000/6)* 0.35) * 3,78448 - $ 768,000
= $ 3,785,952
Computation of Worst Case NPV
Price per unit = $ 60 - 10 % = $ 59,4/ unit
Variable Cost per unit = $ 38.5 per unit
Sales = 51,300 Units
Fixed Cost = $ 847,000
Required Rate of Return = 15 %
NPV (best case) = Present Value of cashflows - Initial Outflow
= (( Sales - Total cost) ( 1 - tax rate) + Depreciation * Present Value factor @ 15 %) - Initial Outflow
= (Operating Cashflows * PVAF @ 15 %) - $768,000
= ( $ 59.4* 51,300 -$ 38,5 * 51,300 - $ 847,000 + ($768,000/6)* 0.35) * 3,78448 - $ 768,000
=$ 2,806,956
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