The most likely outcomes for a particular project are estimated as follows: howe

Question

The most likely outcomes for a particular project are estimated as follows: however, you recognize that some of these estimates are subject to error. Suppose that each variable may turn out to be either 10% higher or 10% lower than the initial estimate. The project will last for 10 years and requires an initial investment of $1.8 million, which will be depreciated straight-line over the project life to a final value of zero. The firm's tax rate is 40% and the required rate of return is 10%. What is project NPV in the best-case that is, assuming all variables take on the best possible value? What is project NPV in the worst- case scenario?

Explanation / Answer

Most likely Best Worst Unit price 60 66 54 Variable cost 40 36 44 Fixed cost 390000 351000 429000 Expected sales year 38000 41800 34200 Conribution per unit 20 30 10 Total Contribution 760000 1254000 342000 Fixed cost 390000 351000 429000 depreciation 180000 180000 180000 Profit before taxes 190000 723000 -267000 less taxes 76000 289200 106800 Profit after taxes 114000 433800 -160200 depreciation 180000 180000 180000 Cash flow after taxes 294000 613800 19800 PVIF of 10 year annuity for 10% 6.144567 6.144567 6.144567 PV of cash flow 1806503 3771535 121662 less initial investment -1000000 -1000000 -1000000 NPV 806503 2771535 -878338 Assumptions used It is assumed that depreciation is not included in fixed cost. It is assumed that the tax benefit of loss in worst scenario can be adjusted against earnings of other projects of the business.

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