5. We are evaluating a project that costs $864,000, has an eight-year life, and
ID: 2806171 • Letter: 5
Question
5. We are evaluating a project that costs $864,000, has an eight-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 71,000 units per year. Price per unit is $49, variable cost per unit is $33, and fixed costs are $765,000 per year. The tax rate is 35 percent, and we require a return of 10 percent on this project.
a. Calculate the accounting break-even point. What is the degree of operating leverage at the accounting break-even point?
b. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales.
c. What is the sensitivity of OCF to changes in the variable cost figure? Explain what your answer tells you about a $1 decrease in estimated variable costs.
Explanation / Answer
Accounting Break even point Contribution per unit =49-33=16 Fixed Cost=765000 Accounting Break even point =(765000+108000)/16 54,563 units DOL=1+(fixed cost/Depreciation)=1+(765000/108000) 8.083 Year - 1 2 3 4 5 6 7 8 NPV Initial outflow -8,64,000 Sales 34,79,000 34,79,000 34,79,000 34,79,000 34,79,000 34,79,000 34,79,000 34,79,000 Variable Cost 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 Contribution 11,36,000 11,36,000 11,36,000 11,36,000 11,36,000 11,36,000 11,36,000 11,36,000 Fixed Cost 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 BTCF 3,71,000 3,71,000 3,71,000 3,71,000 3,71,000 3,71,000 3,71,000 3,71,000 Depreciation -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 EBT 2,63,000 2,63,000 2,63,000 2,63,000 2,63,000 2,63,000 2,63,000 2,63,000 Tax at 35% 92,050 92,050 92,050 92,050 92,050 92,050 92,050 92,050 PAT 1,70,950 1,70,950 1,70,950 1,70,950 1,70,950 1,70,950 1,70,950 1,70,950 Depn 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 ATCF 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 FCF -8,64,000 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 2,78,950 Disc Fact. 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 Disc. Cash flow -8,64,000 2,53,591 2,30,537 2,09,579 1,90,527 1,73,206 1,57,460 1,43,145 1,30,132 6,24,178 Sales qty reduced by 500 Year - 1 2 3 4 5 6 7 8 NPV Initial outflow -8,64,000 Sales 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 Variable Cost 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 23,43,000 Contribution 11,11,500 11,11,500 11,11,500 11,11,500 11,11,500 11,11,500 11,11,500 11,11,500 Fixed Cost 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 BTCF 3,46,500 3,46,500 3,46,500 3,46,500 3,46,500 3,46,500 3,46,500 3,46,500 Depreciation -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 EBT 2,38,500 2,38,500 2,38,500 2,38,500 2,38,500 2,38,500 2,38,500 2,38,500 Tax at 35% 83,475 83,475 83,475 83,475 83,475 83,475 83,475 83,475 PAT 1,55,025 1,55,025 1,55,025 1,55,025 1,55,025 1,55,025 1,55,025 1,55,025 Depn 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 ATCF 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 FCF -8,64,000 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 2,63,025 Disc Fact. 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 Disc. Cash flow -8,64,000 2,39,114 2,17,376 1,97,615 1,79,650 1,63,318 1,48,471 1,34,973 1,22,703 5,39,219 Varaible cost decrease by 1$ Year - 1 2 3 4 5 6 7 8 NPV Initial outflow -8,64,000 Sales 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 34,54,500 Variable Cost 22,72,000 22,72,000 22,72,000 22,72,000 22,72,000 22,72,000 22,72,000 22,72,000 Contribution 11,82,500 11,82,500 11,82,500 11,82,500 11,82,500 11,82,500 11,82,500 11,82,500 Fixed Cost 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 7,65,000 BTCF 4,17,500 4,17,500 4,17,500 4,17,500 4,17,500 4,17,500 4,17,500 4,17,500 Depreciation -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 -1,08,000 EBT 3,09,500 3,09,500 3,09,500 3,09,500 3,09,500 3,09,500 3,09,500 3,09,500 Tax at 35% 1,08,325 1,08,325 1,08,325 1,08,325 1,08,325 1,08,325 1,08,325 1,08,325 PAT 2,01,175 2,01,175 2,01,175 2,01,175 2,01,175 2,01,175 2,01,175 2,01,175 Depn 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 1,08,000 ATCF 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 FCF -8,64,000 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 3,09,175 Disc Fact. 1 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 Disc. Cash flow -8,64,000 2,81,068 2,55,517 2,32,288 2,11,171 1,91,973 1,74,521 1,58,656 1,44,232 7,85,426
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