You are considering a new product launch.The project will cost $1,006,000, have

Question

You are considering a new product launch.The project will cost $1,006,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 360 units per year; price per unit will be $19,800, variable cost per unit will be $16,300, and fixed costs will be $334,000 per year. The required return on the project is 14 percent, and the relevant tax rate is 40 percent.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within

Explanation / Answer

base Best Worst sales 19800.00 19800 19800 Less : variable cost 16300.00 14670 17930 contribution 3500.00 5130.00 1870.00 No. of units 360.00 396 324 Total contribution 1260000.00 2031480.00 605880.00 Less : fixed cost 334000.00 296100.00 361900.00 Profit 926000.00 1735380.00 243980.00 Depreciation working cost 1006000 Life 4 per year 251500 Base case NPV year 0 1-4 investment -1006000.00 Post tax profit 555600 Tax savings due to depreciation 100600 Total -1006000.00 656200 Dcf @ 14 % 1.00 2.91 NPV -1006000.00 1909542 903542.00 Base case NPV 903542.00 Best Case NPV Unit sales +10% variable cost -10% fixed cost -10% Profit 1735380.00 year 0 1-4 investment -1006000.00 Post tax profit 1041228 Tax savings due to depreciation 100600 Total -1006000.00 1141828 Dcf @ 14 % 1.00 2.91 NPV -1006000.00 3322719.48 2316719.48 Best case NPV 2316719.48 Worst Case NPV Unit sales -10% variable cost +10% fixed cost +10% Profit 243980.00 year 0 1-4 investment -1006000.00 Post tax profit 146388 Tax savings due to depreciation 100600 Total -1006000.00 246988 Dcf @ 14 % 1.00 2.91 NPV -1006000.00 718735.08 -287264.92 Worst case NPV -287264.92 base sales 19800.00 Less : variable cost 16300.00 contribution 3500.00 No. of units 360.00 Total contribution 1260000.00 Less : fixed cost x Profit 1260000 - x Base case NPV year 0 1-4 investment -1006000.00 Post tax profit 756000-0.6x Tax savings due to depreciation 100600 Total -1006000.00 856600-0.6x Dcf @ 14 % 1.00 2.91 1006000 = (856600-0.6X)*2.91 1006000 = 2492706-1.746x 1.746X = 1486706 X = 851492.55 Diffrence in Fixed cost Actual 334000 Required to make NPV zero 851492 -517492 Sensitivity 517492/334000 = 155%

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