You are considering a new product launch. The project will cost $857,000, have a
ID: 2742510 • Letter: Y
Question
You are considering a new product launch. The project will cost $857,000, 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 $19,200, variable cost per unit will be $15,100, and fixed costs will be $345,000 per year. The required return on the project is 11 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 ±5 percent.
What are the best and worst case NPVs with these projections?
What is the sensitivity of the NPV to changes in fixed costs?
You are considering a new product launch. The project will cost $857,000, 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 $19,200, variable cost per unit will be $15,100, and fixed costs will be $345,000 per year. The required return on the project is 11 percent, and the relevant tax rate is 34 percent.
Explanation / Answer
(a)
in the below table unit sales, variable cost, and fixed cost are changed to +- 5%
three scenarios
variable
pessimistic (worst case)
most likely
optimistic (best case)
unit price
$19,200
$19,200
$19,200
unit sales
171
180
189
sales(amount)
$3,283,200
$3,456,000
$3,628,800
variable per unit
$15,855
$15,100
$14,345
Variable cost
$2,711,205.00
$2,718,000.00
$2,711,205.00
fixed cost
$362,250.00
$345,000
$327,750.00
depreciation
$214,250
$214,250
$214,250
tax rate
0.34
0.34
0.34
operating cash flow
$211,276.70
$332,225.00
$462,142.70
worst case
best case
NPV
-201,524.58
576,773.56
(b)
base case NPV = 173,710.
(requirement 2)
variable
base case
high fixed cost
low fixed cost
unit price
$19,200
$19,200
$19,200
unit sales
180
180
180
sales(amount)
$3,456,000
$3,456,000
$3,456,000
variable per unit
$15,100
$15,100
$15,100
Variable cost
$2,718,000
$2,718,000
$2,718,000
fixed cost
$345,000
$362,250.00
$327,750.00
depreciation
$214,250
$214,250
$214,250
tax rate
0.34
0.34
0.34
operating cash flow
$332,225
$320,840
$343,610
npv
173,710
138,389
209,031
range of npv = 209,031 - 138,389 = 70642
$70642 is the sensitivity of the NPV to changes in fixed costs.
three scenarios
variable
pessimistic (worst case)
most likely
optimistic (best case)
unit price
$19,200
$19,200
$19,200
unit sales
171
180
189
sales(amount)
$3,283,200
$3,456,000
$3,628,800
variable per unit
$15,855
$15,100
$14,345
Variable cost
$2,711,205.00
$2,718,000.00
$2,711,205.00
fixed cost
$362,250.00
$345,000
$327,750.00
depreciation
$214,250
$214,250
$214,250
tax rate
0.34
0.34
0.34
operating cash flow
$211,276.70
$332,225.00
$462,142.70
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