We are evaluating a project that costs $800,000, has an eight-year life, and has

Question

We are evaluating a project that costs $800,000, has an eight-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 60,000 units per year. Price per unit is $40, variable cost per unit is $20, and fixed costs are $800,000 per year. The tax rate is 35 percent, and we require a return of 10 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

Calculate the best-case and worst-case NPV figures. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)

NPV Best-case $____________

Worst-case $_____________

Explanation / Answer

Base case Best case Worst case sales unit 60000 66000 54000 Sales price per unit 40 44 36 Variable cost per unit 20 18 22 fixed cost 800000 720000 880000 For best case sales units, sales price increase by 10% and variable cost and fixed cost decrease by 10% For worst case sales units, sales price decrease by 10% and variable cost and fixed cost increase by 10% Cash flow Sales revenue 2400000 2904000 1944000 less : variable cost 1200000 1188000 1188000 depriciation 100000 100000 100000 fixed cost 800000 720000 880000 Net Income 300000 896000 -224000 less : income tax @ 35% 105000 313600 0 Net Income after tax 195000 582400 -224000 Cash flow 295000 682400 -124000 NPV= CF * (1-(1+i)-n)/I - Initial investment Best case NPV = -124000 * ( 1 - ( 1+ 0.10)-8)/0.10 - 800000           = -124000 * ( 1 - (1.10)-8)/0.10-800000           = -124000 * ( 1-0.4665)/0.10 - 800000           = -124000 * 0.5335/0.1-80000            = -124000 * 5.335 - 800000           = 3640604 - 800000            = 2840604 Worst case NPV = -124000 * ( 1 - ( 1+ 0.10)-8)/0.10 - 800000           = -124000 * ( 1 - (1.10)-8)/0.10-800000           = -124000 * ( 1-0.4665)/0.10 - 800000           = -124000 * 0.5335/0.1-80000            = -124000 * 5.335 - 800000 = -661540 - 800000            = -1461540

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