We are evaluating a project that costs $1,720,000, has a six-year life, and has

Question

We are evaluating a project that costs $1,720,000, has a six-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 91,000 units per year. Price per unit is $37.95, variable cost per unit is $23.20, and fixed costs are $815,000 per year. The tax rate is 35 percent, and we require a return of 11 percent on this project.

Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±5 percent. Calculate the best-case and worst-case NPV figures. (Do not round intermediate calculations.Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

We are evaluating a project that costs $1,720,000, has a six-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 91,000 units per year. Price per unit is $37.95, variable cost per unit is $23.20, and fixed costs are $815,000 per year. The tax rate is 35 percent, and we require a return of 11 percent on this project.

Explanation / Answer

BASE CASE NPV: Annual OCF: Sales = 91000*$37.95 = 3453450 Variable costs = 91000*$23.20 = 2111200 Fixed costs 815000 Depreciation (1720000/6) 286667 Net operating income 240583 Tax at 35% 84204 NOPAT 156379 Add: Depreciation 286667 OCF 443046 PV of OCF of years 1 to 6 = 443046*4.23054 = 1874323 Less: Initial investment 1720000 NPV 154323 UPPER AND LOWER BOUNDS: Base case Upper bound Lower bound Price per unit $      37.95 $      39.85 $      36.05 Quantity 91000 95550 86450 Variable cost per unit $      23.20 $      24.36 $      22.04 Total fixed costs $ 815,000 $ 855,750 $ 774,250 BEST CASE WORST CASE Price per unit $      39.85 $      36.05 Quantity $    95,550 $   86,450 Variable cost per unit $      22.04 $      24.36 Total fixed costs $ 774,250 $ 855,750 NPV BEST CASE: Annual OCF: Sales = 95550*$39.85 = 3807668 Variable costs = 95550*$22.04 = 2105922 Fixed costs 774250 Depreciation (1720000/6) 286667 Net operating income 640829 Tax at 35% 224290 NOPAT 416539 Add: Depreciation 286667 OCF 703205 PV of OCF of years 1 to 6 = 703205*4.23054 = 2974939 Less: Initial investment 1720000 NPV (Best case) 1254939 Answer NPV WORST CASE: Sales = 86450*$36.05 = 3116523 Variable costs = 86450*$24.36 = 2105922 Fixed costs 855750 Depreciation (1720000/6) 286667 Net operating income -131816 Tax at 35% -46136 NOPAT -85681 Add: Depreciation 286667 OCF 200986 PV of OCF of years 1 to 6 = 200986*4.23054 = 850280 Less: Initial investment 1720000 NPV (Worst case) -869720 Answer

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