A project currently generates sales of $11.5 million, variable costs equal to 40

Question

A project currently generates sales of $11.5 million, variable costs equal to 40% of sales, and fixed costs of $3.4 million. The firm’s tax rate is 40%.

a-1.

What is the effect on project NPV, if sales increase from $11.5 million to $13.5 million? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

a-2.

What is the effect on project NPV, if variable costs increase to 60% of sales? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. Enter your answer as the absolute value of the change.)

b.

If project NPV under the base-case scenario is $3.4 million, how much can fixed costs increase before NPV turns negative? (Do not round intermediate calculations. Enter your answer in dollars not in millions. Round you answer to the nearest dollar amount.)

c.

How much can fixed costs increase before accounting profits turn negative? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

A project currently generates sales of $11.5 million, variable costs equal to 40% of sales, and fixed costs of $3.4 million. The firm’s tax rate is 40%.

Explanation / Answer

Sales = $11.5 millions

Variable cost = 40% of sales

Fixed Cost =$ 3.4 million

Tax rate = 40%

CF = (Sales - variable cost - fixed cost)(1 -Tc )

CF =(11.5 -4.6-3.4)*(1-0.40) =$ 2.1 million

with change in sales

sales = 13.5

CF = (13.5-4.6-3.4)*(1-0.40) =$ 3.3 million

Difference in cash flow = 3.3 -2.1 = $1.2 million

The 12% 10 year annuity factor = 5.65022

The Effect on NPV = change in cash flow x annuitty factor

The Effect on NPV = 1.2 x 5.65022 =$6.780million

a-2 ) if variable cost changed from 40% to 60%

variable cost = 60% of sales = 6.9

OCF at 60% variable cost = (11.5 -6.9-3.4)(1-0.40) = $0.72 million

OCF at 40% variable cost = 2.1 million

Change in cash flow = 2.1 -0.72 = $ 1.38million

The Effect on NPV = 1.38 x 5.65022 = $7.797 million

c) NPV under base case senario = $3.4

Fixed cost can increase to a point where higher cost after taxes reduce NPV by $3.4 million

Increase in Fixed cost x(1- tax rate) x annuity factor (12% 10years ) = 3.4

Increase in Fixed Cost x (1-0.40)x 5.65022 = 3.4

increase in Fixed cost x 3.390132 = 3.4

increase in Fixd cost = 3.4/3.390132 =$1002911

C) Accounting Profit = (sales - variable cost - fixed cost )(1-Tc)

Accounting Profit = (11.5- 4.6-3.4)(1-0.40) = $2.1 miliion

Fixed costs can increase by$ 2.1 million before accounting profits turn negative.

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