Question

We are evaluating a project that costs 680000 has a life of 5 years and has no salvage value. Assume that depreciation is straight line to zero over the life of the project. Sales are projected at 64000 units per year. Price per unit is 46, variable cost per unit is 26, and fixed costs are 685000 per year. The tax rate is 24 percent and we require and return of 14 percent on this project.

Calculate the accounting breakeven point, calculate the base case cash flow and NPV, what is the sensitivity of the NPV to changes in the sales figure, what is the sensitivity of OCF to changes in the variable cost figure???

Answer 1

Answer (a):

The base cash flow and NPV are calculated and given below:

2 Year Project Cost ($680,000) Sales in units Sale price Variable cost per unit 64,000 $46 $26 64,000 $46 $26 64,000 $46 $26 64,000 $46 $26 64,000 $46 $26 Sales Variable cost Fixed cost Depreciation EBT Tax (24%) Net Income Add back depreciation OCF = $2,944,000 $2,944,000 $2,944,000 $2,944,000 $2,944,000 ($1,664,000)| ($1,664,000)| ($1,664,000)| ($1,664,000)| ($1,664,000) ($685,000)| ($685,000)| ($685,000)| ($685,000)| ($685,000) ($136,000)| ($136,000)| ($136,000)| ($136,000)| ($136,000) $459,000 $459,000 $459,000 $459,000 $459,000 ($110,160) ($110,160) ($110,160) ($110,160) ($110,160) $348,840 $348,840 $348,840 $348,840 $136,000 $136,000 $136,000 $136,000 $136,000 $484,840 $484,840 $484,840 $484,840 $484,840 Base case Cash Flows ($680,000) $484,840 $484,840 $484,840 $484,840 $484,840 PV fator (1/(1+34% IAY001 (5680,000. PV fator (1 /(1+14%)^Year) PV of cash flows NPV 11 0.87719298 0.769467528 0.674971516 0.592080277 0.519368664| ($680,000.00)|$425,298.25 $373,068.64 $327,253.19 $287,064.20 $251,810.70 $984,494.98

Accounting break-even point in units = Fixed cost /Contribution per unit

Contribution per unit = 46 - 26 = $20

Fixed costs = 685000 + 136000 = $821000

Accounting break-even point in units = 821000 /20 = 41,050 units

Accounting break-even point in units = 41,050 units

Answer (b):

Sensitivity of NPV to changes in sales units:

ΔNPV = Increase in quantity * Contribution per unit * (1 - Tax rate) * PV factor of $1 annuity at 14% rate

= 1 *20 * (1 - 24%) * (1 - 1 / (1 + 14%)^5)/ 14%

= $52.18

ΔNPV / ΔQ = $52.18

Answer (c):

Sensitivity of OCF to changes in variable cost:

Let us calculate changes in NPV with increase of $1 in variable cost:

Change in OCF = Change in contribution * Quantity * (1 - Tax rate)

= -1 * 64000 * (1 - 24%)

= -$48,640

ΔOCF / ΔVC = - $48,640