You are considering a new product launch. The project will cost $982, 000, have

Question

You are considering a new product launch. The project will cost $982, 000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 300 units per year; price unit will be $19, 200, variable cost per unit will be $15, 700, and fixed costs will be $328, 000 per year. The required return on the project is 12 percent, and the relevant tax rate is 40 percent. 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. Required: What are the best and worst case values for each of the projections? (Do not round intermediate calculations. Round your answers to the nearest whole number (e.g., 32) What are the best- and worst-case OCFs and 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).) What is the base-case OCF and NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) OCF_base $ NPV_base $ What is the OCF and NPV with fixed costs of $338, 000 per year? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) OCF $ NPV $ What is the sensitivity of the NPV to changes in fixed costs? (Do not round intermediate calculations. Input the amount as a positive value. Round your answer to 2 decimal places (e.g., 32.16).)

Explanation / Answer

b)

The OCF and NPV for the worst case estimate are:

OCF worst = [($19,200 – 17,270)(270) – $360,800](0.60) + 0.40($982,000/4)

OCF worst = $194,380

NPV worst = –$982,000 + $194,380(PVIFA 12%,4 )

NPV worst = -$391,609.63

OCF best= [($19,200 – 14,130)(330) – $295,200](0.60) + 0.40($982,000/4)

OCF best= $924,940

NPV best= –$982,000 + $924,940(PVIFA 12%,4 )

NPV best= $1,827,320.26

c)

Using the tax shield approach, the OCF and NPV for the base case estimate is:

OCF base = [($19,200 – 15,700)(300) – $328,000](0.60) + 0.40($982,000/4)

OCF base = $531,400

NPV base = –$982,000 + $531,400(PVIFA 12%,4 ) = $982,000+531,400*3.0373

NPV base = $632,021.22

d)

OCF = [($19,200 – 15,700)(300) – $338,000](0.60) + 0.40($982,000/4)

OCF = $525,400

NPV = –$982,000 + $525,400(PVIFA 12%,4 )

NPV = $613,797.42

e)

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 $338,000. The OCF using this level of fixed costs and the other base-case values with the tax shield approach, we get:

OCF = [($19,200 – 15,700)(300) – $338,000](0.60) + 0.40($958,000/4)

OCF = $525,400

And the NPV is: NPV = –$958,000 + $525,400(PVIFA 12%,4 )

NPV = $613,797.42

The sensitivity of NPV to changes in fixed costs is:

NPV/FC = ($632,021.22– 613,797.42)/($328,000 – 338,000)

NPV/FC = –$1.82

For every dollar FC increase, NPV falls by $1.82

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