You are considering a new product launch. The project will cost $1,450,000, have

Question

You are considering a new product launch. The project will cost $1,450,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $17,000, variable cost per unit will be $10,000, and fixed costs will be $440,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 32 percent.

a. The unit sales, variable cost, and fixed cost projections given above 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? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your NPV answers to 2 decimal places, e.g., 32.16.)

  Scenario         Upper bound                   Lower bound
  Unit sales     _______                             _____units
  Variable cost per unit $ ______            $_______
  Fixed costs $______                             $_______    

  Scenario                 NPV
  Base-case $ _____
  Best-case $ ______
  Worst-case $  ______

b. Calculate the sensitivity of your base-case NPV to changes in fixed costs. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

  NPV/FC $  

c. What is the accounting break-even level of output for this project? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Accounting break-even units

Explanation / Answer

a Details Base Case Best Case Worst Case Unit sales                    160                 176                    144 Price per unit              17,000           17,000              17,000 Unit Variable cost              10,000              9,000              11,000 Fixed cost            440,000         396,000            484,000 NPV -Base Case Year 0 Year 1 Year 2 Year 3 Year 4 Investment      (1,450,000) Sales revenue     2,720,000        2,720,000      2,720,000      2,720,000 Variable cost (1,600,000)      (1,600,000)    (1,600,000)    (1,600,000) Fixed cost       (440,000)         (440,000)       (440,000)       (440,000) Depreciation=       (362,500)         (362,500)       (362,500)       (362,500) Taxable Income         317,500            317,500          317,500          317,500 Tax @32%         101,600            101,600          101,600          101,600 Post Tax Income         215,900            215,900          215,900          215,900 Add back depreciation         362,500            362,500          362,500          362,500 Net Cash flow         578,400            578,400          578,400          578,400 PV factor @12%                         1              0.893                0.797              0.712              0.636 PV of Cash flows      (1,450,000)         516,429            461,097          411,694          367,584 NPV = $ 306,802.86 NPV -Best Case Year 0 Year 1 Year 2 Year 3 Year 4 Investment      (1,450,000) Sales revenue     2,992,000        2,992,000      2,992,000      2,992,000 Variable cost (1,584,000)      (1,584,000)    (1,584,000)    (1,584,000) Fixed cost       (396,000)         (396,000)       (396,000)       (396,000) Depreciation=       (362,500)         (362,500)       (362,500)       (362,500) Taxable Income         649,500            649,500          649,500          649,500 Tax @32%         207,840            207,840          207,840          207,840 Post Tax Income         441,660            441,660          441,660          441,660 Add back depreciation         362,500            362,500          362,500          362,500 Net Cash flow         804,160            804,160          804,160          804,160 PV factor @12%                         1              0.893                0.797              0.712              0.636 PV of Cash flows      (1,450,000)         718,000            641,071          572,385          511,058 NPV = $ 992,514.85 NPV -worst Case Year 0 Year 1 Year 2 Year 3 Year 4 Investment      (1,450,000) Sales revenue     2,448,000        2,448,000      2,448,000      2,448,000 Variable cost (1,584,000)      (1,584,000)    (1,584,000)    (1,584,000) Fixed cost       (484,000)         (484,000)       (484,000)       (484,000) Depreciation=       (362,500)         (362,500)       (362,500)       (362,500) Taxable Income           17,500              17,500            17,500            17,500 Tax @32%              5,600                5,600              5,600              5,600 Post Tax Income           11,900              11,900            11,900            11,900 Add back depreciation         362,500            362,500          362,500          362,500 Net Cash flow         374,400            374,400          374,400          374,400 PV factor @12%                         1              0.893                0.797              0.712              0.636 PV of Cash flows      (1,450,000)         334,286            298,469          266,491          237,938 NPV = $ (312,816.4) b Sensitivity Analysis Base case Best case Change NPV            306,803         992,515            685,712 Fixed cost            440,000         396,000            (44,000) Sensitivity= Change in NPV/Change in Fixed cost= -1558.44% c Base case Accounting Break even Details Base Case Unit sales                    160 Price per unit              17,000 Unit Variable cost              10,000 Unit Contribution Margin                7,000 Fixed cost            440,000 Add Depreciation /year=            362,500 Total Fixed cost (accounting)            802,500 BEP Units =802500/7000=                    115 units

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