Question

We are evaluating a project that costs $660,000, has a five-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 69,000 units per year. Price per unit is $58, variable cost per unit is $38, and fixed costs are $660,000 per year. The tax rate is 35 percent, and we require a return of 12 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. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	NPV
Best-case	$
Worst-case	$

Answer 1

Time line		0	1	2	3	4	5
Cost of new machine		-660000
=Initial Investment outlay		-660000
								100.00%
Unit sales			75900	75900	75900	75900	75900
Profits	=no. of units sold * (sales price - variable cost)		2246640	2246640	2246640	2246640	2246640
Fixed cost			-594000	-594000	-594000	-594000	-594000
-Depreciation	Cost of equipment/no. of years		-132000	-132000	-132000	-132000	-132000	0	=Salvage Value
=Pretax cash flows			1520640	1520640	1520640	1520640	1520640
-taxes	=(Pretax cash flows)*(1-tax)		988416	988416	988416	988416	988416
+Depreciation			132000	132000	132000	132000	132000
=after tax operating cash flow			1120416.00	1120416.00	1120416	1120416	1120416
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							0
Total Cash flow for the period		-660000	1120416	1120416	1120416	1120416	1120416
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.5735194	1.7623417
Discounted CF=	Cashflow/discount factor	-660000	1000371.4	893188.78	797489.98	712044.62	635754.13
NPV=	Sum of discounted CF=	3378848.93

Time line		0	1	2	3	4	5
Cost of new machine		-660000
=Initial Investment outlay		-660000
								100.00%
Unit sales			62100	62100	62100	62100	62100
Profits	=no. of units sold * (sales price - variable cost)		645840	645840	645840	645840	645840
Fixed cost			-726000	-726000	-726000	-726000	-726000
-Depreciation	Cost of equipment/no. of years		-132000	-132000	-132000	-132000	-132000	0	=Salvage Value
=Pretax cash flows			-212160	-212160	-212160	-212160	-212160
-taxes	=(Pretax cash flows)*(1-tax)		-137904	-137904	-137904	-137904	-137904
+Depreciation			132000	132000	132000	132000	132000
=after tax operating cash flow			-5904.00	-5904.00	-5904	-5904	-5904
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							0
Total Cash flow for the period		-660000	-5904	-5904	-5904	-5904	-5904
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.5735194	1.7623417
Discounted CF=	Cashflow/discount factor	-660000	-5271.429	-4706.633	-4202.351	-3752.099	-3350.088
NPV=	Sum of discounted CF=	-681282.60