You are considering a new product launch. The project will cost $2,300,000, have
ID: 2461239 • Letter: Y
Question
You are considering a new product launch. The project will cost $2,300,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $30,000, variable cost per unit will be $18,500, and fixed costs will be $610,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 36 percent.
Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios?
Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
What is the cash break-even level of output for this project (ignoring taxes)? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)
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?
You are considering a new product launch. The project will cost $2,300,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $30,000, variable cost per unit will be $18,500, and fixed costs will be $610,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 36 percent.
Explanation / Answer
1)
Base Case
Initial Investment = 2300000
Annual Depreciation = 2300000/4 = 575000
Sale Price = 30000
Unit Sale = 160
Variable cost per unit = 18500
Fixed Cost = 610000
Required return = 15%
Tax rate = 36%
Annual Cash Flow = ((sale price - Variable cost)*Sales unit - fixed cost)*(1-tax rate) + Annual Deprecaition *tax rate
Annual Cash Flow = ((30000-18500)*160-610000)*(1-36%) + 575000*36%
Annual Cash Flow = 994200
NPV = -initial Investment + Annual Cash Flow*(1-(1+r)^-n)/r
NPV = -2300000 + 994200*(1-(1+15%)^ -4)/15%
NPV = $ 538,419.49
Best Case
Initial Investment = 2300000
Annual Depreciation = 2300000/4 = 575000
Sale Price = 30000
Unit Sale = 160*(1+10%) = 176
Variable cost per unit = 18500*(1-10%) = 16650
Fixed Cost = 610000*(1-10%) = 549000
Required return = 15%
Tax rate = 36%
Annual Cash Flow = ((sale price - Variable cost)*Sales unit - fixed cost)*(1-tax rate) + Annual Deprecaition *tax rate
Annual Cash Flow = ((30000-16650)*176-549000)*(1-36%) + 575000*36%
Annual Cash Flow = 1359384
NPV = -initial Investment + Annual Cash Flow*(1-(1+r)^-n)/r
NPV = -2300000 + 1359384*(1-(1+15%)^ -4)/15%
NPV = $ 1,581,011.99
Worst Case
Initial Investment = 2300000
Annual Depreciation = 2300000/4 = 575000
Sale Price = 30000
Unit Sale = 160*(1-10%) = 144
Variable cost per unit = 18500 *(1+10%) = 20350
Fixed Cost = 610000*(1+10%) = 671000
Required return = 15%
Tax rate = 36%
Annual Cash Flow = ((sale price - Variable cost)*Sales unit - fixed cost)*(1-tax rate) + Annual Deprecaition *tax rate
Annual Cash Flow = ((30000-20350)*144-671000)*(1-36%) + 575000*36%
Annual Cash Flow = 666904
NPV = -initial Investment + Annual Cash Flow*(1-(1+r)^-n)/r
NPV = -2300000 + 666904*(1-(1+15%)^ -4)/15%
NPV = - $ 396003.51
Answer
2)
if only change in fixed cost i.e 10% increase or 10% decrease
Change in Fixed Cost = 10%*610000 = 61000
After tax change in cash flow= 61000*(1-36%) = 39040
NPV change by = 39040*(1-(1+15%)^-4)/15%
NPV change by = 111458.40
NPV/FC = 111458.40/61000
NPV/FC = 182.72%
3) What is the cash break-even level of output for this project (ignoring taxes)? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.)
cash break-even level of output for this project = Fixed Cost/(Sale Price- Variable cost)
cash break-even level of output for this project = 610000/(30000-18500)
cash break-even level of output for this project = 53.04 units
What is the accounting break-even level of output for this project?
Accounting break-even = (Fixed Cost+Depreciation)/(Sale Price- Variable cost)
Accounting break-even = (610000+575000)/(30000-18500)
Accounting break-even = 103.04 Units
What is the degree of operating leverage at the accounting break-even point?
Degree of operating leverage = Contribution Margin/Net Operating Income
Degree of operating leverage = (Sale -Variable cost)*Unit Sale/( (Sale -Variable cost)*Unit Sale-Fixed cost)
Degree of operating leverage = (30000-18500)*103.04/ ( (30000-18500)*103.04 - 610000)
Degree of operating leverage = 2.06
Scenario Unit Sales Variable Cost Fixed Costs NPV Base 160 18500 610000 538,419.49 Best 176 16650 549000 1,581,011.91 Worst 144 20350 671000 -396003.51Related Questions
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