You are considering a new product launch. The project will cost $1,700,000, have

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 140 units per year; price per unit will be $22,000, variable cost per unit will be $12,500, and fixed costs will be $490,000 per year. The required return on the project is 10 percent, and the relevant tax rate is 32 percent.

b.Evaluate the sensitivity of your base-case NPV to changes in fixed costs.

c.What is the cash break-even level of output for this project (ignoring taxes)?

d. What is the accounting break-even level of output for this project?

e. What is the degree of operating leverage at the accounting break-even point?

Explanation / Answer

c)

d)

e)

Degree of operating leverage =(sales variable costs)/(sales variable costs fixed costs)

= 179.3344* (22000 - 12500)/(179.3344* (22000 - 12500) - 490000) = 1.4037

Fixed cost as a fraction of base case 0.9 0.91 0.92 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 1.09 1.1 Actual fixed cost -441000 -445900 -450800 -455700 -460600 -465500 -470400 -475300 -480200 -485100 -490000 -494900 -499800 -504700 -509600 -514500 -519400 -524300 -529200 -534100 -539000 NPV 647348.8 636786.8 626224.8 615662.8 605100.8 594538.8 583976.8 573414.8 562852.8 552290.8 541728.8 531166.9 520604.9 510042.9 499480.9 488918.9 478356.9 467794.9 457232.9 446670.9 436108.9

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