You are considering a new product launch. The project will cost $1,192,500, have

Question

You are considering a new product launch. The project will cost $1,192,500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 230 units per year; price per unit will be $18,500, variable cost per unit will be $15,000, and fixed costs will be $321,000 per year. The required return on the project is 13 percent, and the relevant tax rate is 30 percent.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent.

What are the best and worst case 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 sensitivity of the NPV to changes in fixed costs? (Input the amount as a positive value. Round your answer to 2 decimal places (e.g., 32.16).)

You are considering a new product launch. The project will cost $1,192,500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 230 units per year; price per unit will be $18,500, variable cost per unit will be $15,000, and fixed costs will be $321,000 per year. The required return on the project is 13 percent, and the relevant tax rate is 30 percent.

Explanation / Answer

Working Notes:-

1) Depriciation per year = 1192500/5 = 238500$ per year (Fixed Cost)

Other Fixed Cost = 321000$

Breakeven point as per current scenario = Fixed Cost/(Unit price-Variable Cost)

= (321000+238500)/(18500-15000)

= 160 units

As breakeven point is at 160 units I.e. after sale of 160 units there is the profitable situation.

If sale is below than 160 units, there is total loss i.e. sale is not even capable of recovering its fixed cost.

A) Current Margin =

%age Profit =245500/4009500 = 6.12%

So, if sales is at highest margin, then rate of return is 6.12% in first year (before Tax) and after tax it would be 4.28%

Worst rate is if sale declines beyond the beak even point.

(b) All the calculations, related to Return rate is based on Break even point, which is further based on Fixed Cost.

So, NPV is very sensitive to change in Fixed Cost.

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