You are considering a new product launch. The project will cost $1,750, 000, hav
ID: 2734248 • Letter: Y
Question
You are considering a new product launch. The project will cost $1,750, 000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 220 units per year; price per unit will be $20, 000, variable cost per unit will be $13,000, and fixed costs will be $500, 000 per year. The required return on the project is 15 percent, and the relevant tax rate is 34 percent. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within plusminus 10 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 -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 -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
Sales=220 units
Selling Price per Unit=$20000
Sales Amount=220*20000=$4400000
Variable Cost per Unit=$13000
Variable Cost=220*$13000=$2860000
Contribution=Sales-Variable Cost-= $4400000 - $2860000=$1540000
Contribution Margin(%)= (Contribution/Sales)*100=1540000/4400000= 35%
Depreciation=(Total project cost-Salvage value)/life of the project=(1750000-0)/4=$437500
Break Even Point(in units)= Fixed Cost/Contribution per unit [contribution per unit=sales per unit-Variable cost per unit] =500000/7000=71.42 units
Cash Break Even level of output=Cash Fixed Cost/Contribution per unit [Cash fixed cost=Fixed cost-Depreciation]
=(500000-437500)/7000=8.93 units
Calcution Degree of Operating Leverage At Break even level of output:-
Break Even Sales=Break even units*Selling price per unit=71.43*$20000=1428600
Less :Variable Cost (71.43*$13000) (928590)
Contribution 500000 (approx.)
Less: Fixed Cost (500000)
Net Operating Income Nil
Degree of Operating Leverage= Contribution/Net Opearting Income=500000/0=Infinity
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