Question

A project under consideration costs $400,000, has a five-year life and has no salvage value. Depreciation is straight-line to zero. The firm has made the following projections related to this project Base Case Upper Lower Bound Bound 2,625 $294 $126 $273,000 Unit Sales Price Per Unit Variable Cost Per Unit Fixed Costs 2,500 $280 $120 $260,000 2,375 $266 $114 $247,000 The required return is 10 percent and the tax rate is 30 percent. No additional investment in net working capital is required Requirement 1: What are the worst-case and best-case scenarios for this project? (Input unit sales as number of units. Round all other answers to the nearest whole dollar (e.g 32).) Worst Case Best Case Unit Sales Price Per Unit Variable Cost Per Unit Fixed Costs Requirement 2: Your analysis of the project's NPV in the "base case" shows a NPV of $62,476. However, your boss has asked you to determine the sensitivity of the project's NPV to potential changes in fixed costs. Using the firm's estimate of the highest possible level of fixed costs, complete the table below and use your results to assess the sensitivity of the project's NPV to changes in fixed costs. (Round all answers except your sensitivity estimate to the nearest whole dollar (e.g., 32). Round the sensitivity estimate to 2 decimal places (e.g., 32.16). Negative amounts should be indicated by a minus sign.) Sales Variable Costs Fixed Costs S Depreciation EBIT S Taxes Net Income S Operating Cash Flow Net Present Value (NPV) Sensitivity (ANPVIAFC)

Answer 1

Requirement 1:

For worst case scenario lower bound figures and for best case upper bound figures need to be taken.

Worst case scenario

For lower bound scenario Profit before tax= 2375*(266-114)-247000=114000

Tax=(114000-400000/5)*30%=10200

FCF(Free Cash Flow)=114000-10200=$103800 per year

Year	Cash flow lower case	Present Value of cash flow for lower case (CashFLow/1.1^year)
0	(400,000.00)	(400,000.00)
1	103,800.00	94,363.64
2	103,800.00	85,785.12
3	103,800.00	77,986.48
4	103,800.00	70,896.80
5	103,800.00	64,451.63
	NPV (Total Present Value)	(6,516.33)

Best case scenario

Profit Before Tax=2625*(294-126)-273000=$168000

Tax=(168000-103800)*30%=19260

FCF= 168000-19260=$148740 per year

Year	Cash flow upper case	Present Value of cash flow for upper case (CashFLow/1.1^year)
0	(400,000.00)	(400,000.00)
1	148,740.00	135,218.18
2	148,740.00	122,925.62
3	148,740.00	111,750.56
4	148,740.00	101,591.42
5	148,740.00	92,355.84
	NPV (Total Present Value)	163,841.62

Requirement 2:

For base case

Sales=2500*280=$700000

Variable Cost=2500*120=$300000

Fixed Cost=260000

Depreciation=400000/5=80000

EBIT=700000-300000-260000-80000=60000

Tax=60000*30%=18000

Operating Cash Flow=60000-18000+80000=$122000

Year	Cash flow base case	Present Value of cash flow for base case (CashFLow/1.1^year)
0	(400,000.00)	(400,000.00)
1	122,000.00	110,909.09
2	122,000.00	100,826.45
3	122,000.00	91,660.41
4	122,000.00	83,327.64
5	122,000.00	75,752.40
	NPV (Total Present Value)	62,475.99

Sensitivity= DeltaNPV/Delta FC=((62475-(-6516.33))/(260000-247000)=5.30