You are considering a new product launch. The project will cost $1,212,500, have

Question

You are considering a new product launch. The project will cost $1,212,500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 270 units per year; price per unit will be $18,900, variable cost per unit will be $15,400, and fixed costs will be $325,000 per year. The required return on the project is 13 percent, and the relevant tax rate is 40 percent.

Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent.

What are the best and worst case values for each of the projections? (Do not round intermediate calculations. Round your answers to the nearest whole number (e.g., 32)

What are the best- and worst-case OCFs and NPVs with these projections? (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

You are considering a new product launch. The project will cost $1,212,500, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 270 units per year; price per unit will be $18,900, variable cost per unit will be $15,400, and fixed costs will be $325,000 per year. The required return on the project is 13 percent, and the relevant tax rate is 40 percent.

Explanation / Answer

Answer:(a) The base-case, best-case, and worst-case values are shown below. Remember that in the best-case, unit sales increase, while fixed and variable costs decrease. In the worst case, unit sales decrease, while fixed and variable costs increase.

Answer:(b)

Answer:(c)

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

OCF base = [($18,900 – 15,400)(270) – $325,000](0.60) + 0.40($1212500/5)

OCF base =372000+97000=469000

NPV base = –$1212,500 + $469000(PVIFA 13%,5 )

NPV base = $437,081.46

The OCF and NPV for the worst case estimate are:

OCF worst = [($18,900 – 16940)(243) – $357500](0.60) + 0.40($1212500/5)

OCF worst = =168268

NPV worst = –$1212,500 + $168268(PVIFA 13%,5 )

NPV worst = –$620662.53

And the OCF and NPV for the best case estimate are:

OCF best = [($18,900 – 13,860)(297) – $292500](0.60) + 0.40($1212500/5)

OCF best = $819628

NPV best = –$1212,500 + $819628(PVIFA 13%,5 )

NPV best = $1,670321.224

Answer:D

OCF = [($18,900 – 15,400)(270) – $335,000](0.60) + 0.40($1212500/5)

OCF =463000

NPV = –$1212,500 + $463000(PVIFA 13%,5 )

=415978.07

Scenario Unit sales Variable costs Fixed costs    Base 270 $15,400 $325,000    Best   297 $13,860.0 $292,500.0    Worst 243 $16,940.0 $357,500.0

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