Questio 7. value: 1.38 points e are evaluating a project that costs $924.000, ha

Question

Questio 7. value: 1.38 points e are evaluating a project that costs $924.000, has an eight-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 75,000 units per year Price per unit is $46, variable cost per unit is $31, and fixed costs are $825,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV figures. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g. 32.16)) Best case Worst case $ 2.554,066.81 References eBook & Resources Worksheet ming objective: 11-02 How to perform andi arn scenario analysis for a proposed investment Difficulty: Basic Section 11 2 Scenario and Other What-If Ana

Explanation / Answer

We first need to find the depreciation for each year. The depreciation is:

Depreciation = $924,000/8 = $115,500 per year

We will use the tax shield approach to calculate the OCF for the best- and worst-case scenarios. For the best-case scenario, the price and quantity increase by 10 percent, so we will multiply the base case numbers by 1.1, a 10 percent increase. The variable and fixed costs both decrease by 10 percent, so we will multiply the base case numbers by .9, a 10 percent decrease. Doing so, we get:

OCFbest = {[($46)(1.1) –($31)(0.9)](75000)(1.1) –$825,000(0.9)}(0.65) + 0.35($115,500) = $775,087.50

The best-case NPV is:

NPVbest = –$924,000 + $775,087.50(PVIFA15%,8) = $2,554,066.81

For the worst-case scenario, the price and quantity decrease by 10 percent, so we will multiply the base case numbers by .9, a 10 percent decrease. The variable and fixed costs both increase by 10 percent, so we will multiply the base case numbers by 1.1, a 10 percent increase. Doing so, we get:

OCFworst = {[($46)(0.9) –($31)(1.1)](75000)(0.9) –$825,000(1.1)}(0.65) + 0.35($115,500) = -$229,162.50

The worst-case NPV is:

NPVworst = –$924,000 - $229,162.50(PVIFA15%,8) = -$1,952,320.89

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