Project Analysis [LO1, 2, 3, 4] You are considering a new product launch. The pr
ID: 2688642 • Letter: P
Question
Project Analysis [LO1, 2, 3, 4] You are considering a new product launch. The project will cost $1,400,000, have a four-year life, and have no salvage value; de- preciation is straight-line to zero. Sales are projected at 180 units per year; price per unit will be $16,000, variable cost per unit will be $9,800, and f xed costs will be $430,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 35 percent. What is the accounting break-even level of output for this project? What is the degree of operating leverage at the accounting break-even point? How do you interpret this number?Explanation / Answer
This is a standard textbook and also a real life financial problem.
The short and simple answer is that this is an "arbitrarily" chosen variable simply to demonstrate a point - "Evaluate the sensitivity of your base-case NPV to changes in fixed costs."
And, yes they could have chosen any number within the stated "probably accurate to within 10%."
You could chose to make it +/- 10% of the chosen fixed cost of $380,000; i.e., $418.000 or $342,000, but you will get a Big Fat Zero from your prof. (S)he just wants the answer to the specific question that was asked.
My experience at University graduate and post graduate levels (I have 2 degrees: Electrical Engineering; and, Business Administration and Financial Management) taught me to "just answer the question."
You must understand that this is a specific problem and the teacher/prof just wants a textbook answer to make marking all of the papers as easy as possible.
It is a good idea that you as a student "think" and ask these types of questions. However, the main purpose is to teach a "principle" of how much, or little, (unforeseen) changes in a given situation "could" impact NPV results.
If you are really curious and ambitious, you might try writing a computer program that varies the input value(s) of the fixed costs while listing/charting the numerical values and results of the NPV. Or just try calculating a few other fixed cost values out of curiosity.
Remember this is just a simple single answer text book question, not a scientific statistical research project.
I have a lovely game that I play with my young relatives and the neighbour's children. The questions are always asked in a stern and sometimes slightly angry voice:
1. "What are you doing with my Basketball?"
Much stammering, confusion and even fear. One very bright young man comes by to join in the game. I ask him and he replies simply, "I am playing with it." End of story, and, "Oh, OK, that's nice. I was just asking." - Much to the delight of the almost dozen other boys who didn't just answer the question.
2. To my nieces who drop bye for lunch: "Who said you could go into my frig, make a sub, use my deli meat and help yourself to drinks?"
"Nobody said I could. I decided to and I'm doing it." And, all to good natured laughter.
3. To my employees at work: "Who said you could wear Hush Puppies to work?" Or, "Who said you could wear that Captain Kirk Star Trek costume to work?" (That was the funniest one?) "Nobody said I could. And, I didn't ask." - "Oh, OK, just asking."
So, just answer the question.
I hope you like my answer and enjoyed my stories. I could never just answer a question in a simple way either. My boss actually hated my replies. "Why do you always tell me, in detail, how to build a digital watch whenever I ask you simply for the time."
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