You are considering a new product launch. The project will cost $1,700,000, have
ID: 2680676 • Letter: Y
Question
You are considering a new product launch. The project will cost $1,700,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 190 units per year; price per unit will be $18,000, variable cost per unit will be $11,200, and fixed costs will be $410,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 35 percent.
Required:
(a)
Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within
Explanation / Answer
a)
Sales
190
Particulars
Per Unit ($)
Total ($)
-10%
10%
Sales
18,000
3,420,000
3,078,000
3,762,000
Less: Variable cost
11,200
2,128,000
1,915,200
2,340,800
Contribution
6,800
1,292,000
1,162,800
1,421,200
Less: Fixed Cost
410,000
369,000
451,000
Less: depreciation
425,000
425,000
425,000
Income
457,000
368,800
545,200
Less: Taxes
35%
159,950
129,080
190,820
Net Income
297,050
239,720
354,380
Depreciation
425,000
425,000
425,000
Cash Flow
722,050
664,720
779,380
Discounted Cash Flow for 4 yrs @12%
2,193,118
2,018,987
2,367,249
Project Cost
1,700,000
1,700,000
1,700,000
NPV
493,118
318,987
667,249
b) Sensitivity of NPV = (493,118 - 318,987) / (410,000 - 369,000)
Sensitivity of NPV = 4.247
c) Cash Break-even = (Fixed Cost excluding Depreciation)/ Variable cost per unit
Cash Break-even = 410,000 / 11,000
Cash Break-even = 36.6 = 37 units
d) Accounting Break-even = Fixed Cost including depreciation/ Variable cost per unit = 74.5 units = 75 units
Operating Leverage = Contribution Margin/Net Operating Income =-1.57
This implies that if Sales increase by 1%, EBIT will decrease by 1.57%
Sales
190
Particulars
Per Unit ($)
Total ($)
-10%
10%
Sales
18,000
3,420,000
3,078,000
3,762,000
Less: Variable cost
11,200
2,128,000
1,915,200
2,340,800
Contribution
6,800
1,292,000
1,162,800
1,421,200
Less: Fixed Cost
410,000
369,000
451,000
Less: depreciation
425,000
425,000
425,000
Income
457,000
368,800
545,200
Less: Taxes
35%
159,950
129,080
190,820
Net Income
297,050
239,720
354,380
Depreciation
425,000
425,000
425,000
Cash Flow
722,050
664,720
779,380
Discounted Cash Flow for 4 yrs @12%
2,193,118
2,018,987
2,367,249
Project Cost
1,700,000
1,700,000
1,700,000
NPV
493,118
318,987
667,249
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