We are evaluating a project that costs $768,000, has a six-year life, and has no

Question

We are evaluating a project that costs $768,000, 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 52,000 units per year. Price per unit is $60, variable cost per unit is $35, and fixed costs are $770,000 per year. The tax rate is 35 percent, and we require a return of 15 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV figures.

Explanation / Answer

Calculation of best case NPV (i.e.cost will be lower by 10% and income will be higher by 10%) Year 0 1 2 3 4 5 6 NPV Purchase cost -$768,000.00 Operating Cash flow $760,450.00 $760,450.00 $760,450.00 $760,450.00 $760,450.00 $760,450.00 Net Cash flow -$768,000.00 $760,450.00 $760,450.00 $760,450.00 $760,450.00 $760,450.00 $760,450.00 x Discount Factor @ 15% 1 0.86956522 0.75614367 0.65751623 0.57175325 0.49717674 0.4323276 Present Values -$768,000.00 $661,260.87 $575,009.45 $500,008.22 $434,789.76 $378,078.05 $328,763.52 $2,109,909.86 Best case NPV = $2,109,910 Working Depreciation per year = [Cost - salvage value]/useful life = $768000/6 years = $128000 Calculation of operating cash flow per year Year Per Year Sales (10% higher) $3,432,000 Less : Variable cost (10% lower) $1,638,000 Contribution Margin $1,794,000 Less : Fixed cost (10% lower) $693,000 Less : Depreciation (constant) $128,000 Profit before tax $973,000 Less : Tax @ 35% $340,550 Add : Depreciation $128,000 Operating Cash flow per year $760,450 Calculation of worst case NPV (i.e.cost will be higher by 10% and income will be lower by 10%) Year 0 1 2 3 4 5 6 NPV Purchase cost -$768,000.00 Operating Cash flow $18,150.00 $18,150.00 $18,150.00 $18,150.00 $18,150.00 $18,150.00 Net Cash flow -$768,000.00 $18,150.00 $18,150.00 $18,150.00 $18,150.00 $18,150.00 $18,150.00 x Discount Factor @ 15% 1 0.86956522 0.75614367 0.65751623 0.57175325 0.49717674 0.4323276 Present Values -$768,000.00 $15,782.61 $13,724.01 $11,933.92 $10,377.32 $9,023.76 $7,846.75 -$699,311.64 Worst case NPV = -$699,312 Working Depreciation per year = [Cost - salvage value]/useful life = $768000/6 years = $128000 Calculation of operating cash flow per year Year Per Year Sales (10% lower) $2,808,000 Less : Variable cost (10% higher) $2,002,000 Contribution Margin $806,000 Less : Fixed cost (10% higher) $847,000 Less : Depreciation (constant) $128,000 Profit before tax -$169,000 Less : Tax @ 35% -$59,150 Add : Depreciation $128,000 Operating Cash flow per year $18,150

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