.GoSmart * 90%- 8:50 PM ezto.mheducation.com Problem 11-5 Sensitivity Analysis a

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.GoSmart * 90%- 8:50 PM ezto.mheducation.com Problem 11-5 Sensitivity Analysis and Break-Even ILO 3 We are evaluating a project that costs $500,000, has an eight- year life, and has no salvage value. Assume that depreciation s straight-line to zero over the fe of the project. Sales are projected at 50,000 units per year. Price per unit is S40 variable cost per unit is $25, and fxed costs are $600,000 per year. The tax rate is 35 percent, and we require a return of 12 percent on this project Calculate the accounting break-even point. (Do not round your answer to the nearest whole number, e.g. 32) 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 .9.32.161.) Calculate the base-case cash flow and NPV.(Do not round intermediate calculations. Round your cash flow answer to the nearest whole numbereg-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.9 32.16) What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to the nearest whole number, e.g 32 References&Reues; Leaming Objective 11-03 How to determine and interpret cash, Section 11 4 Operating Cash 3 Check my. work

Explanation / Answer

a.) Annual Depreciation = $500,000/8 =$62,500

Accounting Break-Even = (Fixed Cost + Depreciation)/Contribution Margin

                                   = (600,000 + 62,500)/(40-25)

                                   = 662500/15

                                   = 44,167 units

b.) Degree of Operating Leverage at Accounting Break-Even = 1 + Fixed Cost/Operating Cash Flow

Now, the operating cash flow at accounting breakeven point = Depreciation =$62,500

DOL = 1 + 600,000/62,500

       = 1+ 9.60

       = 10.60

c.) Base Cash Flow = {(P-V)Q - FC}x(1-T) + TD

                     = {(40-25)x50,000 - 600,000}x(1-0.35) + 0.35x62,500

                     = 97,500 + 21,875

                     = 119,375

Salvage Value =$0

NPV of the Project = -500,000 + 119,375 x PVIF(12%,8)

                     = -500,000 + 119,375x4.9676

                     = -500,000 + 593,012

                    = $93,012

d.) Let new quantity sold be 60,000 units

New OCF    = {(P-V)Q - FC}x(1-T) + TD

                  = {(40-25)x60,000 - 600,000}x(1-0.35) + 0.35x62,500

                  = 195,000 + 21,875

                  = 216,875

Salvage Value =$0

NPV of the Project = -500,000 + 216,875 x PVIF(12%,8)

                     = -500,000 + 216,875x4.9676

                     = -500,000 + 1,077,348

                    = $577,348

Senstivity of NPV to Quantity =$(577,348 - 93,012)/(60,000-50,000) =484,336/10,000 =48.43 $/unit

e.) Let new variable cost be $27/unit

New OCF    = {(P-V)Q - FC}x(1-T) + TD

                  = {(40-27)x50,000 - 600,000}x(1-0.35) + 0.35x62,500

                  = 50,000 + 21,875

                  = 71,875

Sensitivity of Variable Cost to OCF = (119,375 - 71,875)/(25-27) =47,500/-2 = -23,750

So, with every $ increase in variable cost, the Operating cash flow reduces by $23,750

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