Question

uul liaie h the exam paper and each of your answer sheets. Epiphany Industries is considering a new capital budgeting project that will last for three I. (10 pts.) years. Epiphany plans on using a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental cash flow projections: Year Sales (Revenues) 100,000 100,000 100,000 50,000 50,000 50,000 30,000 30,000 30,000 20,000 20,000 20,000 Cost of Goods Sold (50% of Sales) -Depreciation EBIT -Taxes (35%) - unlevered net income + Depreciation + changes to working capital 7000 7000 7000 13,000 13,000 13,000 30,000 30,000 30,000 5000 10,000 -5000 90,000 capital expenditures The free cash flow EBIT -Taxes +Depreciation + a. Epiphany would like to know how sensitive the project's NPV is to changes in the Change to working capital discount rate. How much can the NPV change if the discount rate change to either 10.8% or 13.2%? Epiphany is worried about the reliability of the sales forecast. How sensitive is the project's NPV to a 10% change in sales? b. c. What parameter is the NPV more sensitive to? d. Calculate the break-even level for the sales.

Answer 1

1). NPV with discount rate of 12% = 1,270

Formula	Year (n)	0	1	2	3
	Sales		1,00,000	1,00,000	1,00,000
(50% of Sales)	COGS		50,000	50,000	50,000
	Depreciation		30,000	30,000	30,000
(Sales-COGS-Dep.)	EBIT		20,000	20,000	20,000
(35%*EBIT)	Tax @ 35%		7,000	7,000	7,000
(EBIT -Tax)	Unlevered net income		13,000	13,000	13,000
	Add: Depreciation		30,000	30,000	30,000
	Less: Increase in NWC		(5,000)	(5,000)	(5,000)
	Less: Capex	(90,000)
	Free Cash Flow (FCF)	(90,000)	38,000	38,000	38,000
1/(1+d)^n	Discount factor	1.000	0.893	0.797	0.712
(FCF*Discount factor)	PV of FCF	(90,000)	33,929	30,293	27,048
	NPV	1,270

a). Scenario analysis:

	Discount rate	NPV
Base	12.00%	1,270
Best	10.80%	3,185
Worst	13.20%	(580)

b). Sensitivity analysis:

	Sales	NPV
Base (B)	1,00,000	1,270
New (N)	1,10,000	9,076
Change (N-B)	10,000	7,806

Sensitivity of NPV to Sales = 7,806/10,000 = 0.7806 or 78.06%

c). NPV is much more sensitive to Sales as compared to the discount rate.

d). Break-even Sales wil have NPV = 0.

Using Solver, NPV = 0 at Sales = 98,374

Note: The NPV tables for the scenario and sensitivity analysis have not be posted due to the answer word limit. They have been calculated by changing values in the base NPV table posted above.