We are evaluating a project that costs $962,000, has a 10-year life, and has no

Question

We are evaluating a project that costs $962,000, has a 10-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 112,000 units per year. Price per unit is $36, variable cost per unit is $24, and fixed costs are $974,506 per year. The tax rate is 36 percent, and we require a 10 percent return on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/-15 percent.

WHAT ARE THE BEST AND WORST NPVS??

Explanation / Answer

Best Case

Price per unit = 36*(1+15%) = 41.40

variable cost per unit = 24*(1-15%) = 20.40

Contribution Margin = 41.40-20.40 = 21

Fixed Cost = 974506*(1-15%) = $ 828,330.10

Annual Quantity to be sold = 112000*(1+15%) = 128800

Annual Cash Flow = (21*128800- 828330.10)*(1-36%) + 962000/10 * 36%

Annual Cash Flow = $ 1,235,572.736

NPV = - 962000 + 1,235,572.736*PVIFA(10%,10)

NPV = - 962000 + 1235572.736*6.14456711

NPV = $ 6,630,059.60

Worst Case

Price per unit = 36*(1-15%) = 30.60

variable cost per unit = 24*(1+15%) = 27.60

Contribution Margin =30.60-27.60 = 3

Fixed Cost = 974506*(1+15%) = $ 1,120,681.90

Annual Quantity to be sold = 112000*(1-15%) = 95200

Annual Cash Flow = (3*95200- 1120681.90)*(1-36%) + 962000/10 * 36%

Annual Cash Flow = - $ 499920.416

NPV = - 962000 - 499920.416*PVIFA(10%,10)

NPV = - 962000 - 499920.416*6.14456711

NPV = - $ 4,033,794.55

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