Question

We are evaluating a project that costs $924,000, has a four-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 87,600 units per year. Price per unit is $34.55, variable cost per unit is $20.80, and fixed costs are $756,000 per year. The tax rate is 35 percent, and we require a return of 13 percent on this project.

Requirement 1:

Calculate the base-case cash flow and NPV. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

Base-case cash flow	$
NPV	$

Requirement 2:

What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations.Round your answer to 3 decimal places (e.g., 32.161).)

Sensitivity of NPV

$

Requirement 3:

If there is a 500-unit decrease in projected sales, how much would the NPV drop? (Do not round intermediate calculations. Input your answer as a positive value. Round your answer to 2 decimal places (e.g., 32.16).)

NPV drop

$

Requirement 4:

What is the sensitivity of OCF to changes in the variable cost figure? (A negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).)

Sensitivity of OCF

$

Requirement 5:

If there is $1 decrease in estimated variable costs, how much would the increase in OCF be? (Round your answer to the nearest whole dollar amount (e.g., 1,234,567).)

Increase in OCF

$

Answer 1

Compute the base case NPV and the cash flows in the following manner: 1 Requirement 1 2 Initial Cost 3 Life of the 924000 n years Salvage value 5 Depreciation-Cost Life (B2-B4)/B3 Sales 9 Less: Variable Cost 10 Contribution per unit 11 Units 12 Total contribution-Contribution per unit units -B10 B11 13 Less: Fixed costs 14 Less: Depreciation 15 Eaming before interest and taxes 16 Less. Taxes@35% 7 Earnings after tax-EBIT-Tax 18 Add 19 Cash flow after tax 20 21 22 Year 23 1 24 2 25 3 26 4 27 Present value of cash inflows 28 Present value of cash outflows 29 NPV 34.55 20.8 B8-B9 87600 756000 -B5 B12-B13-B14 B15*35% B15-B16 ation(c ted above -B5 B17+B18 Cash flows SBS19 SB$19 SBS19 SB$19 Present value factor Present value B23 C23 B24 C24 B25 C25 B26 C26 SUM(D23:D26 B2 D27-D28 1/1.13 A23 1/1.13 A24 1/1.13"A25 1/1.13 A26 The result will be as follows:

2 3 4 Requirement 1 Initial Cost Life of the Salvage value 924.000 Cost-Salvage valueyLife S231.000 8 Sales S34.55 Less: Variable Cost 10 Contribution per unit 11 Units 13.75 87,600 12 Total contribution Contribution per unit'units S1.204,500 756,000 $231,000 $217,500 13 Less: Fixed costs Less 15 Eaming before interest and taxes 16 Less: Taxesa 35% after tax EBIT-Tax 18 Add 19 Cash flow after tax 141,375.00 231,000.00 $372,375.00 ed above Cash flows Present value factor Present value 372,375.00 0.884955752 372,375.00 0.783146683 t172,375.00 0693050162 S329.535 291,624 $258,075 $228,385 1,107,619 $924.000 S183.618.76 2,375.00 0.613318728 Present value of cash inflows Present value of cash outflows 29 NPV equirement 2 Sensitivity measures the percentage change in NPV due to 1% percentage change in sales figure

Reduced sales figureby 10% -B2"(1-10% 20.8 87600 C2-C3 756000 231000 -C4-C5-C6 0 C7-C8 C6 -C9+C10 Present -34.55#87600 -20.8 87600 2 Sales 3 Less: Variable cost 4 Contribution 5 Less: Fixed costs 6 Less: B2-B3 756000 231000 -B4-B5-B6 ion before interest and taxes 8 Less: Taxes@ 35% 9 Earnings after tax-EBIT-Tax 0 Add:I 11 Cash flow after tax 12 13 B7*35% B7-B8 tion(computed above B6 B9+B10 14 Year 15 1 16 2 17 3 18 4 19 Present value of cash inflows 20 Present value of cash outflows 21 NPV Cash flows =SC$11 -SC$11 -SC$11 -SC$11 Present value factor 1/1.13A15 B15 C15 1/1.13 A16B16 C16 -1/1.13°A 17 |-317*C17 .1/1.13°А 18 |-B18*C18 Present value SUMIDI5:D18 924000 C15 D19-D20 23 24 New NPV 25 Old NPv 26 D21 183618.76 -B25-B24 e in NPV Precentage change in NPV due to 10% 27 change in sales =B26 B25 Precentage change in NPV due to 1% 28 change in sales 29 -B27/10 The result will be as follows:

The result will be as follows: 3026580 1822080 1204500 S756,000.00 S231,000.00 S217,500.00 $76,125.00 $141,375.00 S231,000.00 S372.375.00 Reduced sales figureby 10% 2723922 1822080 901842 $756,000.00 S231,000.00 $85,158.00 S0.00 ($85. I 58.00 $231,000.00 $145.842.00 2 Sales 3 Less: Variable cost 4 Contribution 5 Less: Fixed costs 6 Less before interest and taxes 8 Less. Taxes@35% after tax-EBIT-Tax 10 Add 11 Cash flow after tax 12 13 14 Year 15 16 17 18 19 Present value of cash inflows 20 Present value of cash outflows 21 NPV iation computed above Cash flows $145,842.00 S145,842.00 $145,842.00 $145,842.00 S0.88 Present value factor Present value 0.884955752 0.783146683 0.693050162 0.613318728 S129,064 $114,216 $101,076 $89.448 $433,803 S924.000 ($490,197.15) 23 4 New NPV 25 Old NP 26 Change in NPV ($490,197.15 183618.76 $673,815.91 Precentage change in NPV due to 10% 27 in sales 366.96% Precentage change in NPV due to 190 28 29 in sales 36.70% Therefore, the sensitivity is 36.70% Requirement 3 Compute the NPV if the sales units fall by 500 units.

1 Old units 2 New Units 87600 -B1-500 Present Reduced sales 4 Sales 5 Less: Variable cost 6 Contribution 7 Less: Fixed costs 34.55 87600 B2 34.55 20.8*8760020.8 B2 B4-B5 756000 231000 C4-CS 756000 231000 ess ation 9 E 10 Less. Taxes@ 35% 11 Earnings after tax EBIT-Tax before interest and taxes B6-B7-B8-C6-C7-C8 B9*35% -B9-B10 C9"35% 10 Add: Depreciation(computed above) B8 -B11-B12 12 3 Cash flow after tax 14 15 -C8 İrC11HO2 16 Year 17 1 18 2 19 3 20 4 21 Present value of cash inflows 22 Present value of cash outflows 23 NPV 24 25 26 New NPV 27 Old NPv 28 Cash flows -SC$13 Present value factor Present value -SCS13 -SC$13 -SC$13 1/1.13 A18 -|/1.13°А 19 1/1.13 A20 B17 C17 B18"С 18 B19*C19 B20 C20 SUM(D17:D20) 924000 D21-D22 D23 183618.76 e in NPV B27-B26

The result will be as follows: 1 Old units 2 New Units 87600 87100 Reduced sales Present 3026580 3009305 1822080 1204500 $756,000.00 $756,000.00 S231,000.00 S231,000.00 uantit 500 4 Sales 5 Less: Variable cost 6 Contribution 7 Less: Fixed costs 8 Less 1811680 1197625 eciation Earning before interest and 9 taxes 10 Less. Taxes@35% 11 Earnings after tax-EBIT-Tax$141375.00 S136,906.25 $217,500.00 $210,625.00 S76,125.00 S73.718.75 Add: Depreciation(computed 12 above) 13 Cash flow after tax 14 15 S231,000.00 S231,000.00 S372,375.00 $367,906.25 Present value 16 Year 17 18 19 20 21 Present value of cash inflows 22 Present value of cash outflows 23 NPV 24 25 26 New NPV 27 Old NPv 28 Change in NPV Cash flows factor 367,906.25 0.884955752 S325,581 $367,906.25 0.783146683 S288,125 $367,906.25 0.693050162 $254,977 S367,906.25 0.613318728 $225,644 Present value 1,094,327 $924.000 $170.326.59 S170.326.59 183618.76 S13,292.17 Therefore, the change in NPV is $13292.17 Requirement 4 Compute the sensitivity of OCF with respect to change in variable cost

Requirement 4 Compute the sensitivity of OCF with respect to change in variable cost. Increase variable cost by 10% |-34.55#87600 !:-B3*( 1+10% -C2-C3 756000 231000 2 Sales 3 Less: Variable cost Present -34.55#87600 -20.8*87600 Contribution 5 Less: Fixed costs 6 Less B2-B3 756000 231000 eciation 7 Earning before interest and taxes 8 Less. Taxes@35% 9 Earnings after tax-EBIT-Tax B4-B5-B6C4-C5-C6 -C7*35% -C7-C8 B7-B8 Add: Depreciation(computed above) 10 1 Cash flow after tax C6 -С9tCl 0 -B6 B9+B10

13 Old cash flows 4 New cashflows 5 Change in cash flows B11 C11 B13-B14 Percentage change in cash flows due 16 to 10% change in variable cost B15/B13 Percentage change in cash flows due 7 to 1% change in variable cost B16/10 The result will be as follows: Present 3026580 1822080 1204500 $756,000.00 231,000.00 Increase variable cost by 10% 3026580 2004288 1022292 S756,000.00 S231,000.00 2 Sales 3 Less: Variable cost Contribution 5 Less: Fixed costs 6 Less reciation 7 8 9 Earning before interest and taxes Less. Taxes@35% Earnings after tax-EBIT-Tax $217,500.00 S76,125.00 S141,375.00 S35,292.00 12,352.20 $22,939.80 Add: Depreciation computed above) 10 11 Cash flow after tax 12 13 Old cash flows 14 New cashflows 15 Change in cash flows 231,000.00 372,375.00 S231,000.00 $253,939.80 372,375.00 253,93980 S118.435.20 Percentage change in cash flows due 16 to 10% change in variable cost 31.81% Percentage change in cash flows due 17 to 1% change in variable cost 3.18%