You are considering a new product launch. The project will cost $1, 222, 500, ha

Question

You are considering a new product launch. The project will cost $1, 222, 500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 290 units per year; price per unit will be $19, 100, variable cost per unit will be $15, 600, and fixed costs will be $327,000 per year. The required return on the project is 15 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 plusminus 10 percent. What are the best and worst case NPVs with these projections? What is the base-case NPV? Requirement 2: What is the sensitivity of the NPV to changes in fixed costs?

Explanation / Answer

a)

NPV (Best) = $2,120,441.22

Calculations:

NPV (Worst Case) = -$1800251.67

Calculations:

b) NPV (Base) = $637,803.39

Sensitivity of NPV to changes in fixed costs:

NPV - Best Case (units increase by 10% and fixed and variable costs decrease by 10%) Sales (319*19100) 6092900 Variable Cost(319*14040) 4478760 Contribution 1614140 Fixed cost 294300 Depreciation 244500 Income before tax 1075340 Tax @ 30% 322602 Income after tax 752738 Add: depreciation 244500 Annual cash inflow 997238 pvifa(15,5) 3.3522 PV of cash inflows 3342941.22 Less: Initial investment 1222500.00 NPV 2120441.22

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