We are evaluating a project that costs $1,080,000, has a ten-year life, and has

Question

We are evaluating a project that costs $1,080,000, has a ten-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 52,000 units per year. Price per unit is $50, variable cost per unit is $30, and fixed costs are $730,000 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

step1:
the worst case is when its sales and price per unit projections are less by 10% and variable cost and fixed costs are greater by 10%

price per unit of worst case = 50 * 0.9 = 45

sales of worst case = 52000 * 0.9 = 46800 units

variable costs per unit of worst case = 30 * 1.1 = 33

fixed costs of worst case = 730000 *1.1 = 803000

step2:

Find earnings before income and tx

EBIT = sales * (price - variable cost) - fixed costs

= 46800 * (45-33) - 803000

= -241400

step3:

Find operating cash flow

Depriciation per year = 1080000/10 = 108,000

operating cash flow = -241400 + 108000 = -133400

step4:

find NPV

NPV = -1080000 - 133400 * [1-(1.15)^-10]/0.15

= -1,749,503.74

Now, for the best case , repeate steps 1-4

step1:
the worst case is when its sales and price per unit projections are greater by 10% and variable cost and fixed costs are less by 10%

price per unit of worst case = 50 * 1.1 = 55

sales of worst case = 52000 * 1.1 = 57200 units

variable costs per unit of worst case = 30 * 0.9 = 27

fixed costs of worst case = 730000 *0.9 = 657000

step2:

Find earnings before income and tx

EBIT = sales * (price - variable cost) - fixed costs

= 57200 * (55-27) - 657000

= 944600

step3:

Find operating cash flow

Depriciation per year = 1080000/10 = 108,000

operating cash flow = (944600 -108000) * (1-35%) + 108000 = 651790

step4:

find NPV

NPV = -1080000 +651790 * [1-(1.15)^-10]/0.15

= 2,191,183.20

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