Question

You are considering a new product launch. The project will cost $2,275,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 300 units per year; price per unit will be $19,400, variable cost per unit will be $13,550, and fixed costs will be $690,000 per year. The required return on the project is 10 percent, and the relevant tax rate is 23 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. 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? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.) b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. What is the cash break-even level of output for this project (ignoring taxes)? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) d-1. What is the accounting break-even level of output for this project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) d-2. What is the degree of operating leverage at the accounting break-even point? (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

Answer 1

	Decrease 10%	Base Sales	increase 10%
Sales units	270	300	330
selling price Per Unit	19400	19400	19400
Sales volume ( S.U*S.P P/U)	5238000	5820000	6402000
Minus : Total Variable Cost (S.unit*V C P/U)	3658500	4065000	4471500
Contribution	1579500	1755000	1930500
Contribution P/U	5850	5850	5850
Total Fixed cost	690000	690000	690000
EBIDT	889500	1065000	1240500
Minus : Dep At SLM n=4 Y	568750	568750	568750
EBIT	320750	496250	671750
Minus : Tax @ 23%	73772.5	114137.5	154502.5
EAT	246977.5	382112.5	517247.5
Plus : Depriciation	568750	568750	568750
CFAT	815728	950863	1085998
PV Factor of Interest factor annuities (n=4, r=10%)	3.170	3.170	3.170
PV of CFAT annuities (n=4, r=10%) PVFACTOR *CFAT	2585856	3014234	3442612
Cost of project	2275000	2275000	2275000
NPV = PV OF CFAT -COST OF PROJECT	310856	739234	1167612	Ans of a)

Ans c:

cash break-even level of output for base sales of the project ignoring taxes

= fixed cost /contribution P/U

=690000/5850

=118 units

(Note : in cash BEP we will ignore Dep. as Dep. Being a non cash item)

ans d-1

accounting break-even level of output for base sales of the project

= fixed cost+ Dep /contribution P/U

=690000+568750/5850

=215 units

Ans d-2

DOL in accounting BEP

= contribution margin/EBIDT

=1755000/1065000

=1.647

for calculating option b need information related to % changes in FC.