Breakeven and Sensitivity Analysis The goal of this exercise is to explore the t

Question

Breakeven and Sensitivity Analysis

The goal of this exercise is to explore the trade-offs associated with the NPV of a solar collector project. The QFM for this project is:

1. Development costs are $100K/qtr for Y1.

2. Ramp-Up costs are 10K for Y1 Q4, 50K for Y2 Q1, and 5K for Y2 Q2.

3. Production costs are 20K for Y2 Q1, $22K for Y2 Q2, 25K for Y2 Q3, and 30K for Y2 Q4.

4. Marketing costs are 30K/qtr for Y2.

5. Product support costs are 15K/qtr for Y2.

6. Material costs are 5K/qtr for Y2.

7. Sales Revenue is predicted to be 300K/qtr for Y2.

8. The discount rate our company is using is 8% annually for Y1 and Y2. Original NPV to the nearest dollar = ____________

Your team has presented a project proposal to the management team charged with the responsibility for project approval. The management team has some questions (express all answers to the nearest dollar):

1. The project NPV = _________________ (same as NPV above)

2. How would a 30-percent reduction in marketing costs affect the original NPV?

3. What is the trade-off rule for the marketing cost? Trade-off rules are expressed as the (percent change in NPV/ |percent change in cost or other factor|)*100.

4. Suppose the 30-percent reduction in marketing costs also led to a 10-percent reduction in sales, how would this affect the original NPV?

5. How would a 20-percent increase in development costs (and end one quarter sooner) impact the bottom line if it allowed all other activities to begin one quarter earlier thus ending the project one quarter sooner? How would this affect the original NPV?

6. Suppose the raw-material market shifted in an adverse way and we had to pay 50 percent more for material costs? How would this affect the original NPV?

Explanation / Answer

Amount (in $) Particulars Q1Y1 Q2Y1 Q3Y1 Q4Y1 Q1Y2 Q2Y2 Q3Y2 Q4Y2 Sales Revenue 300000 300000 300000 300000 Less: Costs Development Costs 100000 100000 100000 100000 Ramp-Up Costs 10000 50000 5000 Production Costs 20000 22000 25000 30000 Marketing Costs 30000 30000 30000 30000 Product Support Costs 15000 15000 15000 15000 Material Costs 5000 5000 5000 5000 Total Costs 100000 100000 100000 110000 120000 77000 75000 80000 Surplus/Deficit -100000 -100000 -100000 -110000 180000 223000 225000 220000 Discounted at 8%p.a or 2% per Qtr -98039.22 -96116.88 -94232.23 -101623.00 163031.55 198017.62 195876.04 187767.88 Project NPV 354681.76 2. Effect of a 30-percent reduction in marketing costs on the original NPV is that NPV increased from $354,681.76 to $386,341.54. Amount (in $) Particulars Q1Y1 Q2Y1 Q3Y1 Q4Y1 Q1Y2 Q2Y2 Q3Y2 Q4Y2 Sales Revenue 300000 300000 300000 300000 Less: Costs Development Costs 100000 100000 100000 100000 Ramp-Up Costs 10000 50000 5000 Production Costs 20000 22000 25000 30000 Marketing Costs 21000 21000 21000 21000 Product Support Costs 15000 15000 15000 15000 Material Costs 5000 5000 5000 5000 Total Costs 100000 100000 100000 110000 111000 68000 66000 71000 Surplus/Deficit -100000 -100000 -100000 -110000 189000 232000 234000 229000 Discounted at 8%p.a or 2% per Qtr -98039.22 -96116.88 -94232.23 -101623.00 171183.12 206009.36 203711.08 195449.30 Project NPV 386341.54 3. Trade-off rule for the marketing cost = (percent change in NPV/ |percent change in cost or other factor|)*100 = 27.30 4. The effect of a 30-percent reduction in marketing costs also led to a 10-percent reduction in sales and its effect on the original NPV is that NPV reduced on account of reduction in sales from $354,681.76 to $280,808.95. Amount (in $) Particulars Q1Y1 Q2Y1 Q3Y1 Q4Y1 Q1Y2 Q2Y2 Q3Y2 Q4Y2 Sales Revenue 270000 270000 270000 270000 Less: Costs Development Costs 100000 100000 100000 100000 Ramp-Up Costs 10000 50000 5000 Production Costs 20000 22000 25000 30000 Marketing Costs 21000 21000 21000 21000 Product Support Costs 15000 15000 15000 15000 Material Costs 5000 5000 5000 5000 Total Costs 100000 100000 100000 110000 111000 68000 66000 71000 Surplus/Deficit -100000 -100000 -100000 -110000 159000 202000 204000 199000 Discounted at 8%p.a or 2% per Qtr -98039.22 -96116.88 -94232.23 -101623.00 144011.20 179370.22 177594.28 169844.58 Project NPV 280808.95 5. The effect of a 20-percent increase in development costs (and end one quarter sooner) impact the bottom line if it allowed all other activities to begin one quarter earlier thus ending the project one quarter sooner and its effect on the original NPV is that NPV increased from $354,681.76 to $404,097.73. Amount (in $) Particulars Q1Y1 Q2Y1 Q3Y1 Q4Y1 Q1Y2 Q2Y2 Q3Y2 Q4Y2 Sales Revenue 300000 300000 300000 300000 0 Less: Costs Development Costs 120000 120000 120000 Ramp-Up Costs 10000 50000 5000 Production Costs 20000 22000 25000 30000 0 Marketing Costs 30000 30000 30000 30000 0 Product Support Costs 15000 15000 15000 15000 0 Material Costs 5000 5000 5000 5000 0 Total Costs 120000 120000 130000 120000 77000 75000 80000 0 Surplus/Deficit -120000 -120000 -130000 180000 223000 225000 220000 0 Discounted at 8%p.a or 2% per Qtr -117647.06 -115340.25 -122501.90 166292.18 201977.97 199793.56 191523.24 0.00 Project NPV 404097.73 6. The effect of the raw-material market shifting in an adverse way and we had to pay 50 percent more for material costs and its effect on the original NPV is that NPV reduced from $354,681.76 to $345,887.38. Amount (in $) Particulars Q1Y1 Q2Y1 Q3Y1 Q4Y1 Q1Y2 Q2Y2 Q3Y2 Q4Y2 Sales Revenue 300000 300000 300000 300000 Less: Costs Development Costs 100000 100000 100000 100000 Ramp-Up Costs 10000 50000 5000 Production Costs 20000 22000 25000 30000 Marketing Costs 30000 30000 30000 30000 Product Support Costs 15000 15000 15000 15000 Material Costs 7500 7500 7500 7500 Total Costs 100000 100000 100000 110000 122500 79500 77500 82500 Surplus/Deficit -100000 -100000 -100000 -110000 177500 220500 222500 217500 Discounted at 8%p.a or 2% per Qtr -98039.22 -96116.88 -94232.23 -101623.00 160767.22 195797.69 193699.64 185634.16 Project NPV 345887.38

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