We are evaluating a project that costs $1,160,000, has a ten-year life, and has

Question

We are evaluating a project that costs $1,160,000, has a 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 44,000 units per year. Price per unit is $45, variable cost per unit is $20, and fixed costs are $645,000 per year. The tax rate is 35 percent, and we require a return of 20 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

  

Calculate the best-case and worst-case NPV figures.

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We are evaluating a project that costs $1,160,000, has a 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 44,000 units per year. Price per unit is $45, variable cost per unit is $20, and fixed costs are $645,000 per year. The tax rate is 35 percent, and we require a return of 20 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

Explanation / Answer

Best Case NPV = $1,583,006
Worst Case NPV = -$926,834

Base Best Worst Units 44000 48400 39600 Selling price 45 49.5 40.5 Variable cost per unit 20 18 22 Fixed cost 645000 580500 709500 Sales $1,980,000 $2,395,800 $1,603,800 Less: variable cost $880,000 $871,200 $871,200 Contribution $1,100,000 $1,524,600 $732,600 Less: fixed cost $645,000 $580,500 $709,500 Less: depreciation $116,000 $116,000 $116,000 Profit before tax $339,000 $828,100 -$92,900 Less: taxes $118,650 $289,835 -$32,515 Profit after tax $220,350 $538,265 -$60,385 Add: depreciation $116,000 $116,000 $116,000 Cash flows each year $336,350 $654,265 $55,615 PVAF(20%, 10years) $4 $4 $4 Present value of cash flows $1,410,147 $2,743,006 $233,166 Less: Initial cash outflow $1,160,000 $1,160,000 $1,160,000 NPV $250,147 $1,583,006 -$926,834

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