We are evaluating a project that costs $848,000, has an eight-year life, and has

Question

We are evaluating a project that costs $848,000, 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 62,000 units per year. Price per unit is $40, variable cost per unit is $20, and fixed costs are $625,000 per year. The tax rate is 35 percent, and we require a return of 20 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

Calculate the best-case and worst-case NPV figures.

(Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places, e.g., 32.16.)

NPV Best-case $ ? Worst-case $ ?

(Please answer it as clear as possiable with all the steps)

Explanation / Answer

Best-case scenario

Price = 40 x 1.1 = 44, Quantity = 62,000 x 1.1 = 68,200, VC = 20 x (1 - 10%) = 18, FC = 625,000 x (1 - 10%) = 562,500

Worst-case scenario

Price = 40 x (1 - 10%) = 36, Quantity = 62,000 x 0.9 = 55,800, VC = 20 x (1 + 10%) = 22, FC = 625,000 x (1 + 10%) = 687,500

Here, Sales = Quantity x Price

VC = Quantity x VC

Depreciation = Investment / No. of years = 848,000 / 8 = 106,000

Cash Flows = Investment + Profits + Depreciation

NPV = NPV(rate, CF1...CF8) + CF0 in excel

0 1 2 3 4 5 6 7 8 Investment -848,000 Sales 3,000,800 3,000,800 3,000,800 3,000,800 3,000,800 3,000,800 3,000,800 3,000,800 VC -1,227,600 -1,227,600 -1,227,600 -1,227,600 -1,227,600 -1,227,600 -1,227,600 -1,227,600 FC -562,500 -562,500 -562,500 -562,500 -562,500 -562,500 -562,500 -562,500 Depreciaton -106,000 -106,000 -106,000 -106,000 -106,000 -106,000 -106,000 -106,000 EBT 1,104,700 1,104,700 1,104,700 1,104,700 1,104,700 1,104,700 1,104,700 1,104,700 Tax (35%) -386,645 -386,645 -386,645 -386,645 -386,645 -386,645 -386,645 -386,645 Profits 718,055 718,055 718,055 718,055 718,055 718,055 718,055 718,055 Cash Flows -848,000 824,055 824,055 824,055 824,055 824,055 824,055 824,055 824,055 NPV $ 2,314,030.72

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