We are evaluating a project that costs $660,000, has a five-year life, and has n
ID: 2753775 • Letter: W
Question
We are evaluating a project that costs $660,000, has a five-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 69,000 units per year. Price per unit is $58, variable cost per unit is $38, and fixed costs are $660,000 per year. The tax rate is 35 percent, and we require a return of 12 percent on this project.
What is the degree of operating leverage at the accounting break-even point? (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.)
Calculate the base-case cash flow and NPV. (Do not round intermediate calculations. Round your cash flow answer to the nearest whole number, e.g., 32. Round your NPV answer to 2 decimal places, e.g., 32.16.)
What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the degree of operating leverage at the accounting break-even point? (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.)
Explanation / Answer
1. Degree of operating leverage at break even level is infinite.
2. Cash flow from the project in base case (69000 units per year)
Total Sales = 69000*58 = $4002000
Total operating cost = 69000*38 =$2622000
Total fixed cost = $660000
Hence Earnings before Depreciation and Tax (EBDT) = 4002000-(2622000+660000) = $720000
Using straight line method for 5 years the Depreciation per year = 660000/5 = $132000
Hence EBT = 720000-132000 = $588000
Taking tax rate at 35%, EAT= 588000*(1-0.35) = $382200
Hence cash flow per year from the project is EAT plus Depreciation = 382200+132000= $514200
So total cash flows for 5 years = 514200*5 = $2571000
NPV
Required rate of return is 12%. Hence NPV of the project-
=514200/(1+0.12) + 514200/(1+0.12)2 + 514200/(1+0.12)3 + 514200/(1+0.12)4 + 514200/(1+0.12)5
solving this we get NPV = $1853576
Note- The question has been asked in many multiple parts hence solution to only first 2 parts has been provided.
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