Question

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We are evaluating a project that costs $837,790, 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 62,239 units per year. Price per unit is $36, variable cost per unit is $19, and fixed costs are $424,751 per year. The tax rate is 35%, and we require a return of 17% on this project. In percentage terms, what is the sensitivity of OCF to changes in the variable cost per unit projection? (Round answer to 2 decimal places. Do not round intermediate calculations) Question 6 We are evaluating a project that costs $680,403, has a five-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 45,496 units per year, Price per unit is $45, variable cost per unit is $26, and fixed costs are $525,466 per year. The tax rate is 30%, and we require a return of 21% on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within 10 percent. What is the Best Case NPV? (Round answer to 2 decimal places. Do not round intermediate calculations)

Answer 1

1). OCF = (Sales*(Price per unit - Variable cost per unit) - Fixed cost)*(1-Tax rate) + (Depreciation*Tax rate)

Depreciation = initial cost/life = 837,790/8 = 104,723.75

OCF = (62,239*(36-19) - 424,751)*(1-35%) + (104,723.75*35%) = 448,306.11 (This is the OCF with VC = 19)

Now, assume that VC = 20.

New OCF = (62,239*(36-20) - 424,751)*(1-35%) + (104,723.75*35%) = 407,850.76

Change in OCF = new OCF - old OCF = 407,850.76 -448,306.11 = 40,455.35 (Ignore negative sign as we are measuring sensitivity)

Change in VC = 20-19 = 1

Sensitivity of OCF to VC = (Change in OCF/change in VC)% = 4,045,535.00%

6). Best-case NPV = 1,145,743.95

Formula		Base case	Formula	Best case
	Initial Outlay (IO)	680,403		680,403
	Life (n)	5		5
IO/n	Depreciation (D)	136,080.60		136,080.60
	Sales (S)	45,496	Sbase-case*(1+10%)	50,045.60
	Price per unit (P)	45	Pbase-case*(1+10%)	49.50
	Variable cost per unit (VC)	26	VCbase-case*(1-10%)	23.40
	Fixed cost (FC)	525,466	FCbase-case*(1-10%)	472,919.40
	Tax rate (T)	30%		30%
(S*(P-VC)-FC)*(1-T)+(D*T)	OCF	278,094.78		624,113.71
	Return	21%		21%
Using PV function with OCF	Present Value of OCF (PV)	813,700.97		1,826,146.95
PV - IO	NPV	133,297.97		1,145,743.95