Question

We are evaluating a project that costs $744,000, 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 45,000 units per year. Price per unit is $60, variable cost per unit is $20, and fixed costs are $740,000 per year. The tax rate is 35 percent, and we require a return of 18 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within t10 percent. Calculate the best-case and worst-case NPV figures. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your anwers to 2 decimal places, e.g., 32.16.) NPV Best-case Worst-case

Answer 1

Best case

Time line		0	1	2	3	4	5	6
Cost of new machine		-744000
=Initial Investment outlay		-744000
									100.00%
Unit sales			49500	49500	49500	49500	49500	49500
Profits	=no. of units sold * (sales price - variable cost)		2376000	2376000	2376000	2376000	2376000	2376000
Fixed cost			-666000	-666000	-666000	-666000	-666000	-666000
-Depreciation	Cost of equipment/no. of years		-124000	-124000	-124000	-124000	-124000	-124000	0	=Salvage Value
=Pretax cash flows			1586000	1586000	1586000	1586000	1586000	1586000
-taxes	=(Pretax cash flows)*(1-tax)		1030900	1030900	1030900	1030900	1030900	1030900
+Depreciation			124000	124000	124000	124000	124000	124000
=after tax operating cash flow			1154900	1154900	1154900	1154900	1154900	1154900
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-744000	1154900	1154900	1154900	1154900	1154900	1154900
Discount factor=	(1+discount rate)^corresponding period	1	1.18	1.3924	1.643032	1.9387778	2.2877578	2.6995542
Discounted CF=	Cashflow/discount factor	-744000	978728.8136	829431.1979	702907.7949	595684.57	504817.43	427811.38
NPV=	Sum of discounted CF=	3295381.20

Worst case

Time line		0	1	2	3	4	5	6
Cost of new machine		-744000
=Initial Investment outlay		-744000
									100.00%
Unit sales			40500	40500	40500	40500	40500	40500
Profits	=no. of units sold * (sales price - variable cost)		1296000	1296000	1296000	1296000	1296000	1296000
Fixed cost			-814000	-814000	-814000	-814000	-814000	-814000
-Depreciation	Cost of equipment/no. of years		-124000	-124000	-124000	-124000	-124000	-124000	0	=Salvage Value
=Pretax cash flows			358000	358000	358000	358000	358000	358000
-taxes	=(Pretax cash flows)*(1-tax)		232700	232700	232700	232700	232700	232700
+Depreciation			124000	124000	124000	124000	124000	124000
=after tax operating cash flow			356700	356700	356700	356700	356700	356700
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-744000	356700	356700	356700	356700	356700	356700
Discount factor=	(1+discount rate)^corresponding period	1	1.18	1.3924	1.643032	1.9387778	2.2877578	2.6995542
Discounted CF=	Cashflow/discount factor	-744000	302288.1356	256176.3861	217098.6323	183981.89	155916.86	132132.93
NPV=	Sum of discounted CF=	503594.83