We are evaluating a project that costs $855,000, has an ten-year life, and has n
ID: 2711592 • Letter: W
Question
We are evaluating a project that costs $855,000, has an ten-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 121,000 units per year. Price per unit is $41, variable cost per unit is $26, and fixed costs are $858,420 per year. The tax rate is 32 percent, and we require a 17 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 15 percent. Claculate the best-case and worst-case NPV
Explanation / Answer
Annual depreciation = (cost of asset – salvage value)/ Life
= (855,000 – 0)/10
= 85,500
Depreciation tax shield = Annual depreciation x tax rate
= 85,500 x 32%
= 27,360
Base Case
Best Case
Worst case
Sales
121000
139150
102850
Price
41
47.15
34.85
Variable cost
26
22.1
29.9
Fixed cost
858420
729657
987183
Base Case
Best Case
Worst case
Sales revenue
4961000
6560922.5
3584322.5
Total variable cost
-3146000
-3075215
-3075215
Fixed cost
-858420
-729657
-987183
EBIT
956580
2756050.5
-478075.5
Taxes 32%
-306105.6
-881936.16
152984.16
Net Income
650474.4
1874114.34
-325091.34
Depreciation tax shield
27360
27360
27360
Operating cash flow
677834.4
1901474.34
-297731.34
PV of annuity factor
4.6586
4.6586
4.6586
PV= PV factor x OCF
$3,157,761.79
$8,858,215.26
-$1,387,012.30
NPV = PV of OCF – initial cash outflow
NPV best case = $8,858,215.26 -855,000
= $8,003,215.26
Worst case NPV= -$1,387,012.30 - 855,000
= -$2,242,012.30
Base Case
Best Case
Worst case
Sales
121000
139150
102850
Price
41
47.15
34.85
Variable cost
26
22.1
29.9
Fixed cost
858420
729657
987183
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