Q4: You are considering a new product launch. The project will cost $1,192,500,

Question

Q4:

You are considering a new product launch. The project will cost $1,192,500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 230 units per year; price per unit will be $18,500, variable cost per unit will be $15,000, and fixed costs will be $321,000 per year. The required return on the project is 13 percent, and the relevant tax rate is 30 percent.

Requirement 1:

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent.

(a)

What are the best and worst case NPVs with these projections? (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

  NPVbest:       $

  NPVworst:       $

(b)

What is the base-case NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  NPVbase       $

Requirement 2:

What is the sensitivity of the NPV to changes in fixed costs? (Input the amount as a positive value. Round your answer to 2 decimal places (e.g., 32.16).)

  For every dollar FC increase, NPV falls by?   $

Explanation / Answer

The cost of the project is $1192500 and the depreciation is to be calculated on Straight line basis. So the depreciation for 5 Years = $1192500/5 = $238,500 Sales Per unit= $18,500 Total Sales= 230 units per year Variable cost= $15,000 per unit Fixed costs= $321,000 Tax Rate= 30% Required rate of return= 13% It is given that the units sold, variable cost and fixed cost can fluctuate by +,- 10% in future Case-1 Best Case When sales, variable cost and fixed cost increases by 10% Then the cashflows can be calculated in this way: Year-0 Year-1 Year-2 Year-3 Year-4 Year-5 Revenues $4,680,500 $4,680,500 $4,680,500 $4,680,500 $4,680,500 Fixed costs 353100 353100 353100 353100 353100 Variable costs $3,795,000 $3,795,000 $3,795,000 $3,795,000 $3,795,000 Depreciation $238,500 $238,500 $238,500 $238,500 $238,500 Total Costs 4386600 4386600 4386600 4386600 4386600 EBT $293,900 $293,900 $293,900 $293,900 $293,900 Taxes(30%) $88,170 $88,170 $88,170 $88,170 $88,170 Net income $205,730 $205,730 $205,730 $205,730 $205,730 OCF $444,230 $444,230 $444,230 $444,230 $444,230 Capital Spending $1,192,500 Net Cash flows ($1,192,500) $444,230.00 $444,230.00 $444,230.00 $444,230.00 $444,230.00 Therefore Net present value at 13% = $369,959.64 Case-1 Worst Case When sales, variable cost and fixed cost decreases by 10% Then the cashflows can be calculated in this way: Year-0 Year-1 Year-2 Year-3 Year-4 Year-5 Revenues $3,829,500 $3,829,500 $3,829,500 $3,829,500 $3,829,500 Fixed costs 288900 288900 288900 288900 288900 Variable costs $3,105,000 $3,105,000 $3,105,000 $3,105,000 $3,105,000 Depreciation $238,500 $238,500 $238,500 $238,500 $238,500 Total Costs 3632400 3632400 3632400 3632400 3632400 EBT $197,100 $197,100 $197,100 $197,100 $197,100 Taxes(30%) $59,130 $59,130 $59,130 $59,130 $59,130 Net income $137,970 $137,970 $137,970 $137,970 $137,970 OCF $376,470 $376,470 $376,470 $376,470 $376,470 Capital Spending $1,192,500 Net Cash flows ($1,192,500) $376,470.00 $376,470.00 $376,470.00 $376,470.00 $376,470.00 Therefore Net present value at 13% = $131,632.05 Base Case NPV is when we will take the the Original value of sales , variable cost and fixed cost. Then the cashflows can be calculated in this way: Year-0 Year-1 Year-2 Year-3 Year-4 Year-5 Revenues $4,255,000 $4,255,000 $4,255,000 $4,255,000 $4,255,000 Fixed costs $321,000 $321,000 $321,000 $321,000 $321,000 Variable costs $3,450,000 $3,450,000 $3,450,000 $3,450,000 $3,450,000 Depreciation $238,500 $238,500 $238,500 $238,500 $238,500 Total Costs 4009500 4009500 4009500 4009500 4009500 EBT $245,500 $245,500 $245,500 $245,500 $245,500 Taxes(30%) $73,650 $73,650 $73,650 $73,650 $73,650 Net income $171,850 $171,850 $171,850 $171,850 $171,850 OCF $410,350 $410,350 $410,350 $410,350 $410,350 Capital Spending $1,192,500 Net Cash flows ($1,192,500) $410,350.00 $410,350.00 $410,350.00 $410,350.00 $410,350.00 Therefore Base-case Net present value at 13% = $250,795.85 To find out the NPV sensitivity to Fixed cost changes, make $1000 change in fixed cost and then calculate new NPV So the new fixed cost = $323,000 Then the cashflows can be calculated in this way: Year-0 Year-1 Year-2 Year-3 Year-4 Year-5 Revenues $4,255,000 $4,255,000 $4,255,000 $4,255,000 $4,255,000 Fixed costs $322,000 $322,000 $322,000 $322,000 $322,000 Variable costs $3,450,000 $3,450,000 $3,450,000 $3,450,000 $3,450,000 Depreciation $238,500 $238,500 $238,500 $238,500 $238,500 Total Costs 4010500 4010500 4010500 4010500 4010500 EBT $244,500 $244,500 $244,500 $244,500 $244,500 Taxes(30%) $73,350 $73,350 $73,350 $73,350 $73,350 Net income $171,150 $171,150 $171,150 $171,150 $171,150 OCF $409,650 $409,650 $409,650 $409,650 $409,650 Capital Spending $1,192,500 Net Cash flows ($1,192,500) $409,650.00 $409,650.00 $409,650.00 $409,650.00 $409,650.00 Therefore New Net present value at 13% = $248,333.79 Ans new fixed cost = $322,000 So the required sensitivity = ($250795.85 - $248333.79) / $321000 - $322000 -2.4620619

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