Question

25. Samsung Inc. is considering introducing a new iWatch product whose production would last 5 years. In the base case, the project requires an initial investment of $30 million. The annual fixed cost of production is $3 million and the variable cost is $250 per unit. The investment is depreciated on a straight-line basis over the 5-year period to its expected salvage value of zero The cost of capital is 12%, and profits are taxed at a rate of 40%. Ignore working capital. In addition, Samsung's marketing group has made the following base-case assessment of the iWatch market: Market Size (Annual Total Market Unit Sales) Samsung Share of Market Unit Price 1.0 Million units 10% $400 Note: Samsung Unit Sales Market Size x Samsung Share of Market. Calculate the NPV of the project in this base case. In addition, Samsung is unsure of the true Market Size, so calculate the break-even (NPV 0) Market Size. a. NPV 3.1 million; break-even Market Size 953,024 b. NPV 4.6 million; break-even Market Size 858,032 c. I IPV-_1.1 million, break-even Market Size-1,320,420 d. NPV 5.4 million; break-even Market Size 746,574

Answer 1

The answer is option "b" - NPV = 4.6 million; break-even market size = 858,032

Calculations:

	Year
	1	2	3	4	5
Sales (in $)	40,000,000	40,000,000	40,000,000	40,000,000	40,000,000
Variable costs (in $)	25,000,000	25,000,000	25,000,000	25,000,000	25,000,000
Fixed costs (in $)	3,000,000	3,000,000	3,000,000	3,000,000	3,000,000
Depreciation	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
EBIT	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
Tax @ 40%	2,400,000	2,400,000	2,400,000	2,400,000	2,400,000
Net income	3,600,000	3,600,000	3,600,000	3,600,000	3,600,000
	Year
	1	2	3	4	5
EBIT	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
Add: deprectiation	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
less: tax	2,400,000	2,400,000	2,400,000	2,400,000	2,400,000
Operating cash flow	9,600,000	9,600,000	9,600,000	9,600,000	9,600,000

	Year
	0	1	2	3	4	5
Operating cash flow		9,600,000	9,600,000	9,600,000	9,600,000	9,600,000
Capital spending	-30,000,000
Total cash flow	-30,000,000	9,600,000	9,600,000	9,600,000	9,600,000	9,600,000

Year	Cash flow	1+r	PVIF	PV
0	-30,000,000	1.12	1.0000	-30,000,000
1	9,600,000		0.8929	8,571,429
2	9,600,000		0.7972	7,653,061
3	9,600,000		0.7118	6,833,090
4	9,600,000		0.6355	6,100,974
5	9,600,000		0.5674	5,447,298
			NPV (in $)	4,605,852
			NPV (in million $)	4.6

Break even calculations:

	Year
	1	2	3	4	5
Sales (in $)	34,321,280	34,321,280	34,321,280	34,321,280	34,321,280
Variable costs (in $)	21,450,800	21,450,800	21,450,800	21,450,800	21,450,800
Fixed costs (in $)	3,000,000	3,000,000	3,000,000	3,000,000	3,000,000
Depreciation	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
EBIT	3,870,480	3,870,480	3,870,480	3,870,480	3,870,480
Tax @ 40%	1,548,192	1,548,192	1,548,192	1,548,192	1,548,192
Net income	2,322,288	2,322,288	2,322,288	2,322,288	2,322,288
	Year
	1	2	3	4	5
EBIT	3,870,480	3,870,480	3,870,480	3,870,480	3,870,480
Add: deprectiation	6,000,000	6,000,000	6,000,000	6,000,000	6,000,000
less: tax	1,548,192	1,548,192	1,548,192	1,548,192	1,548,192
Operating cash flow	8,322,288	8,322,288	8,322,288	8,322,288	8,322,288
	Year
	0	1	2	3	4	5
Operating cash flow		8,322,288	8,322,288	8,322,288	8,322,288	8,322,288
Capital spending	-30,000,000
Total cash flow	-30,000,000	8,322,288	8,322,288	8,322,288	8,322,288	8,322,288
	Year	Cash flow	1+r	PVIF	PV
	0	-30,000,000	1.12	1.0000	-30,000,000
	1	8,322,288		0.8929	7,430,614
	2	8,322,288		0.7972	6,634,477
	3	8,322,288		0.7118	5,923,640
	4	8,322,288		0.6355	5,288,964
	5	8,322,288		0.5674	4,722,290
				NPV (in $)	-14
				NPV (in million $)	0.0