Question

Windhoek Bakeries has identified a niche market in which they would sell a special type of bread to high

schools in Namibia. Since this is a special type of bread that is not being manufactured currently,

Windhoek Bakeries expects that they will be in business for two years before competitors enter the

market. As such they have planned for this two year horizon after which they will review their business

plan. The initial baking equipment required to facilitate this project will cost Windhoek Bakeries

N$7 000 000. They expect to generate a revenue of N$6 500 000 in each of the two years with at a

selling price of $10 per unit. The total variable costs for the bakery are expected to be N$2 000 000 for

each of the two years. The required rate of return on similar projects is 8%.

Requirement:

What is the sensitivity of this project to changes in:

i) initial investment

ii) sales volume

iii) selling price

iv) variable cost per unit

v) cost of capital. (15

marks)

vi) Explain the meaning of sensitivity analysis and determine to which variable the project is

more sensitive to?

Answer 1

(i) Initial Investment:

Initital Investment = initial baking equipment required to facilitate this project = N$ 7,000,000

(ii) Sales Volume:

Sales Volume = Sales Revenue / Selling Price per unit

Sales Volume = 6,500,000 / 10 = 650,000

Hence,the sales volume is N$ 650,000

(iii) Selling price = N$ 10.00 per unit

(iv) Variable cost per unit:

Variable cost per unit = Total Variable cost / Number of sales unit

Variable cost per unit = 2,000,000 / 650,000 = N$ 3.08 per unit

Hence,the variable cost per unit is N$ 3.08 per unit.

(v) Cost of capital is the required rate of return on similar project. Hence,the cost of capital is 8 %.

(vi) Sensitivity analysis is the assessment of the impact for an sales revenue of a firm by changing its variables like variables cost, cost of capital etc.

The variable cost is more sensitive to the sales revenue of the project. It is because, variable cost is directly proportional to the sales revenue.