You are considering a new product launch. The project will cost $875,000, have a

Question

You are considering a new product launch. The project will cost $875,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 190 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 35 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 NPVs with these projections? (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

What is the sensitivity of the NPV to changes in fixed costs? (Do not round intermediate calculations. Input the amount as a positive value. Round your answer to 2 decimal places (e.g., 32.16).)

You are considering a new product launch. The project will cost $875,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 190 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 35 percent.

Explanation / Answer

Requirement 1:

a) best case scenario :- price and quantity is increased by 10% , variable cost and fixed cost decrease by 10%

sales[(190 + 19) * ($19200+1920)] = $4414080

less: variable cost[(190+19) * ($15100 - 1510)] = $2840310

less: fixed cost (345000 -34500) =310500

less: depreciaiton($875000 / 4year) =218750

profit before tax =1044520

less: tax 35% =365582

profit after tax =678938

add: depreciaiton = 218750

cash inflow =897688

Present value of cash inflow = $897688 * PVAF(11%,4 year)

   = $897688 * 3.102

   = $2784628

NPV for best case =2784628 - 875000

   = $1909628

NPV worst case scenario :- price and quantity is decreased by 10% , variable cost and fixed cost increased by 10%

   sales[(190-19 * ($19200 -1920)] = $2954880

less: variable cost[(190-19 * ($15100 + 1510)] = 2840310

less: fixed cost (345000+ 34500) = 379500

less: depreciaiton($875000 / 4year) =218750

profit before tax =(483680)

less: tax 35% =169288

profit after tax =(652968)

add: depreciaiton = 218750

cash inflow =(434218)

Present value of cash inflow = ($434218) * PVAF(11%,4 year)

   = ($434218) * 3.102

   =( $1346944)

NPV for worst = -1346944 - 875000

=- $2221944

b) Cash inflow per year:

sales(190 * $19200) = $3648000

less: variable cost(190 * $15100) = 2869000

less: fixed cost =345000

less: depreciaiton($875000 / 4year) =218750

profit before tax =215250

less: tax 35% =75338

profit after tax =139912

add: depreciaiton = 218750

cash inflow =358662

Present value of cash inflow = $358662 * PVAF(11%,4 year)

   = $358662 * 3.102

   = $1112570

NPV = 1112570 - 875000

   = $237570

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