We are evaluating a project that costs $943,000, has an eight-year life, and has

Question

We are evaluating a project that costs $943,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 156,000 units per year. Price per unit is $37, variable cost per unit is $28, and fixed costs are $960,917 per year. The tax rate is 37 percent, and we require a 13 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 17 percent.

Calculate the best-case NPV.

Calculate the worst-case NPV.

Explanation / Answer

For best case scenario Unit sales and price are increased by 17% while the variable costs and fixed costs are reduced by 17%.

For worst case scenario Unit sales and price are decreased by 17% while the variable costs and fixed costs are increased by 17%.

OCF = (Sales - Costs)*(1-tax) + Tax*depreciaiton per year

Best-case :

OCF = ((43.29-23.24)*182520-797561.11)*(1-0.37) + 0.37*943000/8 = 1846651.63

NPV = -943000 + 1846651.63/(1+0.13)^1 + 1846651.63/(1+0.13)^2 + 1846651.63/(1+0.13)^3 + 1846651.63/(1+0.13)^4 + 1846651.63/(1+0.13)^5 + 1846651.63/(1+0.13)^6 + 1846651.63/(1+0.13)^7 + 1846651.63/(1+0.13)^8 = $7918656.99

Worst case:

OCF = ((30.71-32.76)*129480-1124272.89)*(1-0.37) + 0.37*943000/8 = -831901.59

NPV = -943000 + (-831901.59)/(1+0.13)^1 + (-831901.59)/(1+0.13)^2 + (-831901.59)/(1+0.13)^3 + (-831901.59)/(1+0.13)^4 + (-831901.59)/(1+0.13)^5 + (-831901.59)/(1+0.13)^6 + (-831901.59)/(1+0.13)^7 + (-831901.59)/(1+0.13)^8 = -$4935104.64

Unit Sales Price Variable costs Fixed costs Base 156000.00 37.00 28.00 960917.00 Best 182520.00 43.29 23.24 797561.11 Worst 129480.00 30.71 32.76 1124272.89

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