You are considering a new product launch. The project will cost $960,000, have a

Question

You are considering a new product launch. The project will cost $960,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 240 units per year; price per unit will be $25,000; variable cost per unit will be $19,500; and fixed costs will be $830,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 35 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

CHANGE VALUES

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%
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