Question

We are evaluating a project that costs $936,000, 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 100,000 units per year. Price per unit is $41, variable cost per unit is $26, and fixed costs are $850,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

a) Calculate the accounting break-even point. What is the degree of operating leverage at the accounting break-even point?

b. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales.

c. What is the sensitivity of OCF to changes in the variable cost fi gure? Explain what your answer tells you about a $1 decrease in estimated variable costs.

d. In the above problem, 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.

Answer 1