You are considering a new product launch. The project will cost $2,350,000, have

Question

You are considering a new product launch. The project will cost $2,350,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $31,000, variable cost per unit will be $19,000, and fixed costs will be $620,000 per year. The required return on the project is 14 percent, and the relevant tax rate is 34 percent.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios?(Negative amount should be indicated by a minus sign. Round your NPV answers to 2 decimal places. (e.g., 32.16))

Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (Negative amount should be indicated by a minus sign. Round your answer to 3 decimal places. (e.g., 32.161))

What is the cash break-even level of output for this project (ignoring taxes)? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the accounting break-even level of output for this project? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the degree of operating leverage at the accounting break-even point? (Round your answer to 3 decimal places. (e.g., 32.161))

You are considering a new product launch. The project will cost $2,350,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $31,000, variable cost per unit will be $19,000, and fixed costs will be $620,000 per year. The required return on the project is 14 percent, and the relevant tax rate is 34 percent.

Explanation / Answer

Question a. Senario Variance Unit Sales Sales Variable Cost Fixed Cost Income NPV Base 0% 150 4650000 2850000 620000 1180000 767040.0 Best 10% 165 5115000 3135000 682000 1298000 843744 Worst -10% 135 4185000 2565000 558000 1062000 690336 Year Cash Outflows PV Factor @14% Present Value 0 -2350000 1.000000 -2350000.0 1 1295500 0.877193 1136403.5 2 1295500 0.769468 996845.2 3 1295500 0.674972 874425.6 4 1295500 0.592080 767040.0 Sales 4650000 Variable Cost 2850000 1800000 Less Fixed Cost 620000 Net Income 1180000 Tax @40 % 472000 Income after Tax 708000 Add Depreciation 587500 Cash Inflows 1295500 Question b. Best Worst Sales 4650000 4650000 Variable Cost 2850000 2850000 1800000 1800000 Less Fixed Cost 558000 682000 Net Income 1242000 1118000 Tax @40 % 496800 447200 Income after Tax 745200 670800 Add Depreciation 587500 587500 Cash Inflows 1332700 1258300 NPV for Best Fixed Cost: Year Cash Outflows PV Factor @14% Present Value 0 -2350000 1.000000 -2350000.0 1 1332700 0.877193 1169035.1 2 1332700 0.769468 1025469.4 3 1332700 0.674972 899534.5 4 1332700 0.592080 789065.4 Total 1533104.4 NPV for worst Fixed Cost: Year Cash Outflows PV Factor @14% Present Value 0 -2350000 1.000000 -2350000.0 1 1258300 0.877193 1103771.9 2 1258300 0.769468 968221.0 3 1258300 0.674972 849316.7 4 1258300 0.592080 745014.6 Total 1316324.2 Change in NPV 216780.2 Change in Fixed Cost 124000 Sensitivity 1.75 Question c. Fixed Cost 620000 Add Required Return 329000 949000 Break Even Unit 80 units (949000/12000) Question d. 1 Sales per unit 31000 Variable cost 19000 Contribution 12000 Break even point = Fixed cost / unit contribution =620000/12000 =51.6667 = 52 unit Question d. 2 Degree of Operating Leverage = Change in Income/Change in Sales =(1298000-1062000)/(5115000-4185000) =236000/930000 =0.254

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