We are evaluating a project that costs $1,610,000, has a seven-year life, and ha

Question

We are evaluating a project that costs $1,610,000, has a seven-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 87,500 units per year. Price per unit is $34.50, variable cost per unit is $20.75, and fixed costs are $755,000 per year. The tax rate is 40 percent, and we require a return of 12 percent on this project.

Requirement 1:

What is the sensitivity of NPV to changes in the sales figure?

Requirement 2:

If there is a 500-unit decrease in projected sales, how much would the NPV drop?

Requirement 3:

What is the sensitivity of OCF to changes in the variable cost figure?

Requirement 4:

If there is $1 decrease in estimated variable costs, how much would the increase in OCF be?

Explanation / Answer

Ans 1 Current NPV NPV with 1% increase in sales figure Initial Cost   (A) 16,10,000 Initial Cost   (A) 16,10,000 Sales Revenue Per Year 30,18,750.00 Sales Revenue Per Year 30,48,937.50 Variable cost per Year 18,15,625.00 Variable cost per Year 18,15,625.00 Contribution 12,03,125.00 Contribution 12,33,312.50 Fixed cost per Year     7,55,000.00 Fixed cost per Year     7,55,000.00 Operating Cash infow     4,48,125.00 Operating Cash infow     4,78,312.50 Operating cash flow net off tax     2,68,875.00 Operating cash flow net off tax     2,86,987.50 Depreciation Tax Shield        92,000.00 Depreciation Tax Shield        92,000.00 Net Cash inflow after Depreciation tax shield     3,60,875.00 Net Cash inflow after Depreciation tax shield     3,78,987.50 PVDF @ 12% for 7 Years 4.563756539 PVDF @ 12% for 7 Years 4.563756539 Present value of Cash inflows   (B) 16,46,945.64 Present value of Cash inflows   (B) 17,29,606.68 NPV        36,945.64 NPV     1,19,606.68 Increase in NPV/Base NPV 224% 1% increase in sales figure PA caused 224% change in NPV Ans 2 Current NPV NPV with 1% increase in sales figure Initial Cost   (A) 16,10,000 Initial Cost   (A) 16,10,000 Sales Revenue Per Year 30,18,750.00 Sales Revenue Per Year 30,01,500.00 Variable cost per Year 18,15,625.00 Variable cost per Year 18,15,625.00 Contribution 12,03,125.00 Contribution 11,85,875.00 Fixed cost per Year     7,55,000.00 Fixed cost per Year     7,55,000.00 Operating Cash infow     4,48,125.00 Operating Cash infow     4,30,875.00 Operating cash flow net off tax     2,68,875.00 Operating cash flow net off tax     2,58,525.00 Depreciation Tax Shield        92,000.00 Depreciation Tax Shield        92,000.00 Net Cash inflow after Depreciation tax shield     3,60,875.00 Net Cash inflow after Depreciation tax shield     3,50,525.00 PVDF @ 12% for 7 Years 4.563756539 PVDF @ 12% for 7 Years 4.563756539 Present value of Cash inflows   (B) 16,46,945.64 Present value of Cash inflows   (B) 15,99,710.76 NPV        36,945.64 NPV       -10,289.24 Drop in NPV        47,234.88 %Increase(decrease) in NPV/Base NPV 128% 500 units reduction caused 128% reduction in NPV

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