We are evaluating a project that costs $1,446,000, has a six-year life, and has

Question

We are evaluating a project that costs $1,446,000, has a six-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 88,600 units per year. Price per unit is $35.05, variable cost per unit is $21.30, and fixed costs are $766,000 per year. The tax rate is 30 percent, and we require a return of 11 percent on this project.

1) Calculate the base-case cash flow and NPV.

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

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

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

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

We are evaluating a project that costs $1,446,000, has a six-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 88,600 units per year. Price per unit is $35.05, variable cost per unit is $21.30, and fixed costs are $766,000 per year. The tax rate is 30 percent, and we require a return of 11 percent on this project.

1) Calculate the base-case cash flow and NPV.

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

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

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

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

Explanation / Answer

Answer:1

NPV=-1446000+388875*PVIFA(11%,6)(4.2305)

=$199135.6875

Answer:2 To calculate the sensitivity of NPV to changes in the quantity sold, we will calculate the NPV at a different quantity . We will use sales of 90000 units. The NPV at this sales level is:

NPV=-1446000+402350*PVIFA(11%,6)(4.2305)

=$256141.675

So, the changes in the NPV for every unit change in sales is:

change in NPV/Change in sales unit=($199135.6875-$256141.675)/(88600-90000)

=+40.71856

Answer:3 If sales were to drop by 500-unit, than NPV would drop by:

NPV drop=$40.71856*(500)

=20359.28

Answer:4 suppose vc is $ 22.00

So, change in OCF/Change in variable cost

=($388875-$345461)/(21.30-22)

=-$62020

If variable cost increase by 0.7 than ocf would dec by $62020

Answer:5

So, change in OCF/Change in variable cost

=($388875-$450895)/(21.30-20.30)

=-$62020

If variable cost decrease by 1 than ocf would inc by $62020

Particulars Amount ($) Sales 3105430 88600*35.05 Less: variable cost 1887180 88600*21.30 Contribution margin 1218250 Less: Fixed cost 766000 Less: Dep 241000 1446000/6 EBIT 211250 Less: taxes 63375 EAT 147875 Add:Dep 241000 OCF 388875

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