You are considering a new product launch. The project will cost $1,850, 000. hav

Question

You are considering a new product launch. The project will cost $1,850, 000. have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 180 units per year; price per unit will be $22,000, variable cost per unit will be $14,000, and fixed costs will be $520, 000 per year. The required return on the project is 12 percent, and the relevant tax rate is 36 percent. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within plusminus10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Negative amount should be indicated by a minus sign. Round your NPV answers to 2 decimal places, (e.g., 32.16)) Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (Negative amount should be indicated by a minus sign. Round your answer to 3 decimal places, (e.g., 32.161))______What is the cash break-even level of output for this project (ignoring taxes)? (Round your answer to 2 decimal places, (e.g., 32.16))______What is the accounting break-even level of output for this project? (Round your answer to 2 decimal places, (e.g., 32.16))______What is the degree of operating leverage at the accounting break-even point? (Round your answer to 3 decimal places, (e.g., 32.161))______

Explanation / Answer

a.The base case, best case and worst case values are given above. Remember that in best case sale unit will increae and variable cost and fixed cost will decrease and in worst case sale unit will decrease and variable cost and fixed cost will increase.

Using the tax shield approach, the OCF and NPV for the base case estimate is

OCF base = (($22,000 – 14,000)(180) – $520,000)(0.64) + 0.36($1,850,000/4)]

OCF base = $755,300

NPV base = –$1,850,000 + $755,300 (PVIFA12%,,4 yrs)

NPV base = $444,110

OCF worst = (($22,000 – 15,400)(162) – $572,000)(0.64) + 0.36($1,850,000/4)]

OCF worst = $484,708

NPV worst = –$1,850,000 + $ 484,708 (PVIFA12%,,4 yrs)

NPV worst = ($377,772)

OCF best = (($22,000 – 12,600)(198) – $468,000)(0.64) + 0.36($1,850,000/4)]

OCF best = $1058,148

NPV best = –$1,850,000 + $1058,148 (PVIFA12%,,4 yrs)

NPV best= $1,363,965

b. To calculate the sensitivity of the NPV to changes in fixed costs, we choose another level of fixed costs. We will use Fixed cost of $530,000.The OCF using this level of fixed cost and other base case values with tax shield approach we get,

OCF base = (($22,000 – 14,000)(180) – $530,000)(0.64) + 0.36($1,850,000/4)]

OCF base = $748,900

NPV base = –$1,850,000 + $748,900 (PVIFA12%,,4 yrs)

NPV base = $424,671

The Sensitivity of NPV to changes in the fixed costs is :

Change in NPV / Change in Fixed Cost = ($444,110- $424,671)/ ($520,000-$530,000)

= ($1.94)

For every $ Fixed cost increases NPV falls by ($1.94).

c. Cash break even output for this project = Fixed cost / Contribution per unit =$520000/ ($22,000-$14,000)

= 65 units

d-1 Accounting break even output for this project = Fixed cost + Depreciation / Contribution per unit

=($520000+ (($1,850,000/4) )/ ($22,000-$14,000)

= ($520000+ $462,500 )/ ($22,000-$14,000)

= $982,500 / $8000

= 122.81 units or apprx 123 units

d-2 Degree of Operating Leverage at accounting break even point = Contribution Margin/ Net Income

Degree of Operating Leverage at accounting break even point = Contribution Margin/ Net Income

= $1440,000/ $457,500

= 3.15

$ Sales (22000*180)     3,960,000 Less: Variable Cost(14000*180)     2,520,000 Contribution margin     1,440,000 Less :Fixed Cost       520,000 Less: Depreciation       462,500 Profit/Net income       457,500

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.