Inc. is considering a new product. The proposal is as follows: Project cost: $2,
ID: 2651916 • Letter: I
Question
Inc. is considering a new product. The proposal is as follows:
Project cost: $2,000,000
Project life: 5 yrs
Salvage value: zero
Depreciation: straight line to zero
Sales projection: 180 units per year
Price per unit: $20,000
Variable cost per unit will be: $12,400
Fixed costs per year: $490,000
Required return on the project: 10%
Relevant tax rate: 35%
Based on our past experience, the unit sales, variable costs and fixed cost projections are probably accurate to within plus or minus 10%
A] What are the upper and lower bounds for these projections?
B] What is the base case NPV?
C] What are the best case NPV and the worst case NPV scenarios?
D] Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
E] What is the cash break-even level of output for this project (ignoring taxes)?
F] What is the accounting break-even level of output for this project? What is the degree of operating leverage at the accounting break-even point? How do you interpret this number?
Explanation / Answer
A)
B&C)
D)
Base Case Upper Boundary Lower Boundary Sales Volume 180 198 162 Price Per Unit $20,000.00 $20,000.00 $20,000.00 Variable Cost Unit -$12,400.00 -$13,640.00 -$11,160.00 Contribution per Unit $7,600.00 $6,360.00 $8,840.00 Total Contribution $13,68,000.00 $12,59,280.00 $14,32,080.00 Fixed Cost Per Annum -$4,90,000.00 -$5,39,000.00 -$4,41,000.00 Depreciation( Fixed cost assumed to be exclusive of ddepreciation) -$4,00,000.00 -$4,00,000.00 -$4,00,000.00 Operating Margin $4,78,000.00 $3,20,280.00 $5,91,080.00 Less Tax @ 35% $1,67,300.00 $1,12,098.00 $2,06,878.00 PAT $3,10,700.00 $2,08,182.00 $3,84,202.00 Add: Depreciation Being Non Cash Expense $4,00,000.00 $4,00,000.00 $4,00,000.00 Cash inflow $7,10,700.00 $6,08,182.00 $7,84,202.00 Present Value of Cash inflow $26,94,112.16 $23,05,488.28 $29,72,742.57 Project Cost $20,00,000.00 $20,00,000.00 $20,00,000.00 NPV $6,94,112.16 $3,05,488.28 $9,72,742.57