Use the following information to answer questions 1 and 2. DeLorm Productions is
ID: 2645485 • Letter: U
Question
Use the following information to answer questions 1 and 2.
DeLorm Productions is considering the introduction of a new product. Production of the new product requires an investment of $150,000 in equipment that has a five-year life. The equipment has no salvage value at the end of five years and will be depreciated on a straight-line basis. DeLorm's required return is 15%, and the tax rate is 34%. The firm has made the following forecasts:
Base case
Lower bound
Upper bound
Unit sales
29,000
1,750
2,250
Price per unit
$55
$50
$60
Variable costs per unit
$22
$21
$23
Fixed costs per year
$10,000
$9,500
$10,500
1.
a. Compute the annual OCF for the project, using the base case forecast for each variable.
b. Compute the NPV for the project, using the base case forecast for each variable.
2.
Compute the NPV and the IRR for the project under the best case and worst case scenarios.
Base case
Lower bound
Upper bound
Unit sales
29,000
1,750
2,250
Price per unit
$55
$50
$60
Variable costs per unit
$22
$21
$23
Fixed costs per year
$10,000
$9,500
$10,500
Explanation / Answer
1a, b)
OCF of the project
2)
NPV for the worst case = -24551 $
NPV for the best case = 45137 $
Calcualtion of IRR,
Applying interpolation and the above data,
IRR of the worst case scenario = 15% + [(0 + 24551)/(3450 + 24551)] x (7% - 15%) = 7.98%
IRR of the best case scenario = 15% + [(0-45137)/(-8213 - 45137)] x (30% - 15%) = 23.32%
1a, b)
OCF of the project
Base case lower bound upper bound Unit Sales (a) 29000 1750 2250 Sales price per unit($) (b) 55 50 60 Variable cost per unit ($)(c) 22 21 23 Sales Revenue ($) (axb) 1595000 87500 135000 Less: Variable cost ($) (axc) 638000 36750 51750 Contribution 957000 50750 83250 Less: Fixed cost ($) 10000 9500 10500 Net Profit ($) 947000 41250 72750 Less: Depreciation 30000 30000 30000 Profit before tax 917000 11250 42750 Tax @ 34% 311780 3825 14535 Profit after tax 605220 7425 28215 Add: Depreciation 30000 30000 30000 Operating Cash Flow ($) (d) 635220 37425 58215 PVIFA(15%,5) (e) 3.352 3.352 3.352 PV of cash flow ($) (dxe) 2129257 125448.6 195136.68 Less: PV of cash outflow($) 150000 150000 150000 NPV 1979257 -24551.4 45136.68