Question

Orcid Berhad is considering a project which requires an investment of RM200,000, and the managers are somewhat confident of their estimates of all the project’s cash flow variables except for unit sales.

Further, they consider a drop in sales below 30,000 units or a rise above 50,000 units as being extremely unlikely.

The selling price per unit is RM20. The labor costs per unit are RM8 and the material costs per unit are RM3. The fixed costs are RM50,000 per annum (relevant) and the project does not require any additional working capital.

The projected project is for a year and the cost of capital is 10%.

From the above information you are required to answer the following questions.

1. Calculate the Net Present Value for this project under best-case scenario and worst-case scenario. Given below is the estimated figure under different scenario:                 

	Selling price	Labor costs	Material costs
Best-case	+5%	- 5%	- 5%
Worst-case	-5%	+5%	+5%

                                                                                                               

2. Based on your answer in part (a), interpret your findings.                                  

P/S : PLEASE PROVIDE FULL CALCULATION .

Answer 1

First let us breakdown the unit economics of the best case and worst case

Best Case Scenario
Units	50,000
Selling price	21
Labor Cost	7.6
Material cost	2.85
Fixed Cost	50,000
Investment	200,000
Cost of capital	10%

Best Scenario Cash Flows
Yr 0	Yr 1
-200,000	477,500

Year 1 Cash flows = Units *( Selling price - Labour cost - Material Cost) - Fixed Cost

best case NPV = 234,091

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Worst Case Scenario
Units	30,000
Selling price	19
Labor Cost	8.4
Material cost	3.15
Fixed Cost	50,000
Investment	200,000
Cost of capital	10%

Worst Scenario Cash Flows
Yr 0	Yr 1
-200,000	173,500

Year 1 Cash flows = Units *( Selling price - Labour cost - Material Cost) - Fixed Cost

Worst case NPV = -42,273

b) based on the above calculation, if the best case scenario works out, the company will stand to make a handsome return, or else in the worst case scenario there will be a loss.

But what is more important is that there is a high deviation with these scenarios, and in the event of an average case, the company will stand to make a handsome profit and hence this project should be undertaken