Question

You are considering a new product launch. The project will cost $820,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 450 units per years; price per unit will be $18,000; variable cost per unit will be $15,400; and fixed costs will be $610,000 per year. The required return on the project is 15% and the tax rate is 35%.

a) Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to with plus/minus 10%. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios.

b) Evaluate the sensitivity of your base-case NPV to changes in fixed costs.

c) What is the accounting break-even level of output for this project?

Answer 1

G3 X I J Sale PBT Tax@35% PAT K L M N O P Depreciat Operating Total cash PVIF@ ion cash flows Investment flows 15% Present value (820,000) (820,000) 1.000 (820,000.00) 205,000 435,750 435,750 0.870 378,913.04 205,000 435,750 435,750 0.756 329,489.60 205,000 435,750 435,750 0.658 286,512.70 205,000 435,750 435,750 0.572 249,141.48 124,250 124,250 124,250 124,250 230,750 230,750 230,750 230,750 Base case NPV 424,056.82 Tax@35% fix =+M2*-0.25 A B C D E F G H Sales Variabl Contributio Fixed Deprecia 1 Year units price e cost n per unit costs tion 2 0 1 450 18,000 15,400 2,600 610,000 205,000 355,000 2 450 18,000 15,400 2,600 610,000 205,000 355,000 5 3 450 18,000 15,400 2,600 610,000 205,000 355,000 4 450 18,000 15,400 2,600 610,000 205,000 355,000 7 8 9 Sales Sale Variabl Contributio Fixed Deprecia 10 Year units price e cost n per unit costs tion PBT 11 12 1 450 18,000 15,400 2,600 620,000 205,000 345,000 2 450 18,000 15,400 2,600 620,000 205,000 345,000 14 3 450 18,000 15,400 2,600 620,000 205,000 345,000 4 450 18,000 15,400 2,600 620,000 205,000 345,000 16 17 18 Sales Sale Variabl Contributio Fixed Deprecia 19 Year units price e cost n per unit costs tion PBT 20 0 21 1 495 18,000 13,860 4,140 549,000 205,000 1,295,300 2 495 18,000 13,860 4,140 | 549,000 205,000 1,295,300 23 3 495 18,000 13,860 4,140 549,000 205,000 1,295,300 4 495 18,000 13,860 4,140 549,000 205,000 1,295,300 25 26 120,750 120,750 120,750 120,750 Depreciat Operating Total cash PVIF@ PAT i on cash flows Investment flows 15% Present value (820,000) (820,000) 1.000 (820,000.00) 224,250 205,000 429,250 429,250 0.870 373,260.87 224,250 205,000 429,250 429,250 0.756 324,574.67 224,250 205,000 429,250 429,250 0.658 282,238.84 224,250 205,000 429,250 429,250 0.572 245,425.08 NPV with fixed costs change 405,499.46 Tax@35% 453,355 453,355 453,355 453,355 Depreciat Operating Total cash PVIF@ PAT i on cash flows Investment flows 15% Present value (820,000)| (820,000) 1.000 $ (820,000.00) 841,945 205,000 1,046,945 1,046,945 0.870 $ 910,386.96 841,945 205,000 1,046,945 1,046,945 0.756 $ 791,640.83 841,945 205,000 1,046,945 1,046,945 0.658 $ 688,383.33 841,945 205,000 1,046,945 1,046,945 0.572 $ 598,594.20 Best case NPV $ 2,169,005.32

E49 ✓ fc =(F3+G3/E3 X C D G E Contribution ucion per unit F Fixed Fixed costs Deprecia tion Sale price Variable cost A B Sales 28 Year units 29 0 1 405 2 405 3 405 33 4 405 H I J K L M N O Depreciat Operating Total cash PVIF@ PBT Tax@35% PAT ion cash flows Investment flows 15% Present value (820,000) (820,000) 1.000 $ (820,000.00) (446,700)| (156,345) (290,355) 205,000 (85,355) (85,355) 0.870 $ (74,221.74) (446,700) (156,345) (290,355) 205,000 (85,355) (85,355) 0.756 $ (64,540.64) (446,700) (156,345) (290,355) 205,000 (85,355)| (85,355) 0.658 $ (56,122.30) (446,700) (156,345) (290,355) 205,000 (85,355) (85,355) 0.572 $ (48,802.00) 18,000 $ 18,000 $ 18,000 $ 18,000 $ 16,940 16,940 16,940 16,940 $ $ $ $ 1,060.00 671,000 205,000 1,060.00 671,000 | 205,000 1,060.00 671,000 205,000 1,060.00 671,000 205,000 34 35 Worst case NPV -$1,063,686.68 36 37 a) 38 Scenario Upper bound Lower bound Units sales 495 405 units Variable cost per unit $ 16,940 $ 13,860 Fixed costs $ 671,000 $ 549,000 39 40 41 42 Scenario Base 43 NPV $ 424,056.82 $ 2,169,005.32 $1,063,686.68 44 Best Worst 45 46 47 b) 48 49c) ANPV/AFC $1.86 Accounting break-even 313.46

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