You are considering a new product launch. The project will cost $2,050,000, have

Question

You are considering a new product launch. The project will cost $2,050,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 170 units per year; price per unit will be $26,000, variable cost per unit will be $16,000, and fixed costs will be $560,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 30 percent.

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

Explanation / Answer

Upper and lower bound projections for this project are as follows:

Worst case scenario (lower bound):
Unit sales will decrease by 10% = 170*90% = 153 units
Variable cost per unit will increase by 10% = $16000*110% = $17,600
Fixed cost will increase by 10% = $560,000*110% = $616,000

Best case scenario (upper bound:
Unit sales will increase by 10% = 170*110% = 187 units
Variable cost per unit will decrease by 10% = $16000*90% = $14,400
Fixed cost will decrease by 10% = $560,000*90% = $504,000

Net present value calculation:

Cash and accounting break-even:

Sensitivity of your base-case NPV to changes in fixed costs

Sensitivity of NPV to changes in the fixed cost = Change in NPV

Base Case Worst Case Best Case Units 170.00 153.00 187.00 Sales price per unit 26,000.00 26,000.00 26,000.00 Variable Cost per unit 16,000.00 17,600.00 14,400.00 Contribution per unit (Sales price per unit - Variable cost per unit) 10,000.00 8,400.00 11,600.00 Total Contribution (Contribution per unit * Units sold) 1,700,000.00 1,285,200.00 2,169,200.00 Fixed Cost 560,000.00 616,000.00 554,400.00 Depreciation 512,500.00 512,500.00 512,500.00 Income before tax 627,500.00 156,700.00 1,102,300.00 Tax on income @ 30% 188,250.00 47,010.00 330,690.00 Net income 439,250.00 109,690.00 771,610.00 Operating Cashflow (Net Income + Depreciation) 951,750.00 622,190.00 1,284,110.00

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