You are considering a new product launch. The project will cost $2,350,000, have
ID: 2733902 • Letter: Y
Question
You are considering a new product launch. The project will cost $2,350,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $31,000, variable cost per unit will be $19,000, and fixed costs will be $620,000 per year. The required return on the project is 14 percent, and the relevant tax rate is 34 percent.
a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios?
b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
c. What is the cash break-even level of output for this project (ignoring taxes)?
d-1 What is the accounting break-even level of output for this project?
d-2 What is the degree of operating leverage at the accounting break-even point?
Explanation / Answer
a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios?
b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
To calculate the sensitivity of the NPV to changes in fixed costs we choose another level of fixed costs. We will use fixed costs of $630000 The OCF using this level of fixed costs and the other base case values with the tax shield approach, we get:
The sensitivity of NPV to changes in fixed costs is:
($560688 -481983)/ (620000-630000)=For every dollar FC increase, NPV falls by $1.92
The cash breakeven is:
QC = FC/(P – v)
QC = $620,000//($31,000 – 19,000)
QC = 52
The accounting breakeven is:
QA = (FC + D)/(P – v)
QA = [$620,000 + 2,350,000/4/($31,000 – 19,000) QA = 101
Scenario Unit sales Variable cost Fixed costs Base 150 19000 620000 Best 165 20900 682000 Worst 135 17100 558000Related Questions
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