A project currently generates sales of $11.5 million, variable costs equal to 40
ID: 2654033 • Letter: A
Question
A project currently generates sales of $11.5 million, variable costs equal to 40% of sales, and fixed costs of $3.4 million. The firm’s tax rate is 40%.
a-1.
What is the effect on project NPV, if sales increase from $11.5 million to $13.5 million? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)
a-2.
What is the effect on project NPV, if variable costs increase to 60% of sales? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. Enter your answer as the absolute value of the change.)
b.
If project NPV under the base-case scenario is $3.4 million, how much can fixed costs increase before NPV turns negative? (Do not round intermediate calculations. Enter your answer in dollars not in millions. Round you answer to the nearest dollar amount.)
c.
How much can fixed costs increase before accounting profits turn negative? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)
A project currently generates sales of $11.5 million, variable costs equal to 40% of sales, and fixed costs of $3.4 million. The firm’s tax rate is 40%.
The project will last for 10 years. The discount rate is 12%.Explanation / Answer
Values in $ Mio Revenue per year 11.5 Variable Cost per year -4.6 Fixed Cost (Annual) -3.4 Gross Cash Flow 3.5 Tax implication @ 40% -1.4 Net Cash Flow per year 2.1 Net Present Value for 10 years (considering this cash flow) = $ 3,865,468.36 = $ 3.86 million Scenario 1 Values in $ Mio Revenue per year 13.5 Variable Cost per year -5.4 Fixed Cost (Annual) -3.4 Gross Cash Flow 4.7 Tax implication @ 40% -1.88 Net Cash Flow per year 2.82 Net Present Value for 10 years (considering this cash flow) = $ 7,133,628.94 = $ 7.13 million Hence, change in Cash Flow = 7.13 - 3.86 = $ 3.27 million Scenario 2 Values in $ Mio Revenue per year 11.5 Variable Cost per year -6.9 Fixed Cost (Annual) -3.4 Gross Cash Flow 1.2 Tax implication @ 40% -0.48 Net Cash Flow per year 0.72 Net Present Value for 10 years (considering this cash flow) = -$ 6,231,839.42 = - $ 6.23 million Hence, in this scenario, the cash flow goes down by $ 10.13 millon (3.86 + 6.23) Scenario 3 Values in $ Mio Revenue per year 11.5 Variable Cost per year -4.6 Fixed Cost (Annual) -4.28 Gross Cash Flow 2.62 Tax implication @ 40% -1.05 Net Cash Flow per year 1.57 Net Present Value for 10 years (considering this cash flow) = $ 2,150.60 Hence, fixed costs can increase by $ 0.88 million before the NPV turns negative, considering the base-case scenario. Scenario 4 Values in $ Mio Revenue per year 11.5 Variable Cost per year -4.6 Fixed Cost (Annual) -6.9 Gross Cash Flow 0 Tax implication @ 40% 0 Net Cash Flow per year 0 Checking this scenario, it can be incurred that fixed costs need to be increased by $3.5 million, since at that value, the Net Cash Flow (Accounting Profit) is ZERO.
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