Question

Question 2 25 Marks Kavango Ltd is considering investing in a project at a cost of N$3 000 000. The estimated economic life of the project is 5 years. The company will use the straight-line method to depreciate the cost of the project over 5 years. The company estimates that sales will amount to 240 000 units per year at an estimated selling price of N$40 per unit. The company expects to incur fixed overheads, excluding depreciation of N$300 000 per year and variable cost per unit isN$30. The company cost of capital is 11% and the corporate tax rate is 28%. The expected residual value of the project in 5 years' time is expected to be zero. Required: a) Use the sensitivity analysis to determine what the NPV of the project would be if selling price, sales volume, and variable cost per unit are increased or reduced by 10% (20 marks) b) Use break-even analysis to determine the minimum sales volume that the company is required to achieve to break-even in terms of NPV. (5 marks)

Answer 1

CALCULATION OF NET PRESENT VALUE:
	YEAR	1	2	3	4	5
1	Sales (Units)	2,40,000	2,64,000	2,90,400	3,19,440	3,51,384
2	Selling price	40	44.00	48.40	53.24	58.56
3	Sales (1*2)	96,00,000	1,16,16,000	1,40,55,360	1,70,06,986	2,05,78,453
4	Variable cost (Per unit)	30	33.00	36.30	39.93	43.92
5	Variable cost (4*1)	72,00,000	87,12,000	1,05,41,520	1,27,55,239	1,54,33,839
6	Amortisation of project (30,00,000/5years)	6,00,000	6,00,000	6,00,000	6,00,000	6,00,000
7	Depreciation	3,00,000	3,00,000	3,00,000	3,00,000	3,00,000
8	Total (5+6+7)	81,00,000	96,12,000	1,14,41,520	1,36,55,239	1,63,33,839
9	Profit before tax	15,00,000	20,04,000	26,13,840	33,51,746	42,44,613
10	Tax (9*28%)	4,20,000	5,61,120	7,31,875	9,38,489	11,88,492
11	Profit after tax (9-10)	10,80,000	14,42,880	18,81,965	24,13,257	30,56,121
12	Present value factor @ 11%	0.9009	0.8116	0.7312	0.6587	0.5935
13	Discounted cash flow	9,72,973	11,71,074	13,76,076	15,89,687	18,13,659
14	Total	69,23,469.94
15	Net present value (NPV) = Present value of cash outflows - initial investment
		= 6923470-3000000
		= 3923469.93
	ASSUMPTION:
	It is assumed that growth rate is +10% each year

PART B: CALCULATION OF BREAKEVEN SALES:

A. Fixed cost = Depreciation + Amortisation of project cost = 3,00,000 + 6,00,000 = 9,00,000

B. Variable cost per unit = 30

C. Contribution margin per unit = Sales - Variabe cost = 40-30 = 10

D. Break even units = Total Fixed cost / Contribution margin = 9,00,000/10 = 90,000

E. Break even Sales = Breakeven units * Selling price = 90,000 * 40 = $36,00,000