A project requires an investment of $1,000,000. Although sales will begin in the

Question

A project requires an investment of $1,000,000. Although sales will begin in the first year, operations will not achieve full scale until Year 2. After that, growth is expected to be strong. The product is expected to sell for $100 per unit. Variable costs per unit are $60. Allocable fixed costs are $300,000 per year. Projected units produced and sold per year are:

Year Units

0 NA

1 5,000

2 10,000

3 12,000

4 14,000

5 16,000

At the end of Year 5, the value of the project as an ongoing concern will be 2.5x net operating profit (assume positive cash flow = net operating profit throughout the projection)

1. At what quantity is breakeven achieved?

2. During which year is that achieved?

3. Using an average of 13,000 units sold after Year 1, and incorporating the year 1 loss as an investment, how many years after year 1 will it take to achieve payback?

4. The company uses a required rate of 12%; it also assigns an ongoing value of 2.5 times year 5 net operating profit to the project. What is the NPV for the five year projection?

5. Based on your answers to 1-4, would you recommend that the company proceed with the project?

Explanation / Answer

Answer :

(1) At what quantity BEP is achieved

BEP is as follow

100x = 60 x + $ 300,000

40 x =300,000

x=7,500 units

at 75000 unites break even quantity is achieved

2. During which year is that achieved?

As we can see from the above figure that during the year 1 units of production is 5,000 units and in the year 2 units of production is 10,000 units . So we can say that breakeven achieved between yeat 1 and year 2 mean it is achieved at 1.5 year

3. Using an average of 13,000 units sold after Year 1, and incorporating the year 1 loss as an investment, how many years after year 1 will it take to achieve payback?

To calculate a more exact payback period: Payback Period = Amount to be initially invested / Estimated Annual Net Cash Inflow.

So total amount to calculate pay bsck period is 1,000,000+100,000

So total of 5 year is 860,000

So we could say that it is not coved by 5 year

4. The company uses a required rate of 12%; it also assigns an ongoing value of 2.5 times year 5 net operating profit to the project. What is the NPV for the five year projection?

Fixed Cost +

Variable Cost

At the end of Year 5, the value of the project as an ongoing concern will be 2.5x net operating profit

So value of the project is 1204,000 x 2.5 times so value is 3,010,000

5 Based on the above calculation we could recomend the company should not go for the project

year Csh flow Fixed Cost Variable Cost Net Cashflow 0 (1,000,000) (1,000,000) 1 500,000 300,000 300,000 (100,000) 2 1,000,000 300,000 600,000 100000 3 1,200,000 300,000 720,000 180,000 4 1,400,000 300,000 840,000 260,000 5 1,600,000 300,000 960,000 340,000

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