We are evaluating a project that costs $924,000, has an eight-year life, and has

Question

We 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

We 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

Explanation / Answer

Base case

Sales = 75000 units p/a , P = $46 , VC = $31 , FC = $825000 , Depreciation = 924000/8 = $115500

Best case ( Benefits increase by 10% and costs decrease by 10% )

Sales = 75000*(1 + 0.1) = 82500 , P = 46*(1+0.1) = $50.6 , VC = 31*(1-0.1) = $27.9 , FC = 825000*(1-0.1) = $742500

EBIT = Sales*(P-VC) - FC - Depreciation = 82500*(50.6 - 27.9) - 742500 - 115500 = $1014750

OCF = EBIT*(1-T) + Depreciation = 1014750*(1-0.35) + 115500 = $775087.5

NPV(Best Case) = -Investment + (OCF/r)*(1-(1+r)^-n)

r = 0.15 , n = 8

NPV(Best Case) = -924000 + (775087.5/0.15)*(1-(1.15)^-8) = $2554066.8

Worst case ( Benefits decrease by 10% and costs increase by 10% )

Sales = (1-0.1)*75000 = 67500 , P = (1-0.1)*46 = $41.4 , VC = (1+0.1)*31 = $34.1 , FC = (1+0.1)*82500 = $907500

EBIT = 67500*(41.4-34.1) - 907500 - 115500 = -$530250

OCF = -530250(1-0.35) + 115500 = -$229162.5

NPV(Worst case) = -924000 + (-229162.5/0.15)*(1-(1.15)^-8) = -$1952325.81

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