Question

The Rustic Welt Company is considering launching a new product. The new equipment costs $9 million and falls under straight line depreciation. The depreciation rate will be 10% each year for the next 10 years. The sale price is $8 per welt. The variable costs is a welt to $4 per welt. However, as the following table shows, there is some uncertainty about both the future number of unit sold:

	Pessimistic	Expected	Optimistic
Units sold	400,000	500,000	700,000

a. calculate the NPV for the expected case

b. Conduct a sensitivity analysis assuming a discount rate of 12%. Rustic does not pay taxes and there is no change in NWC.

Answer 1

a	Year	0	1	2	3	4	5	6	7	8	9	10	Total
	Initial Investment	$ (9,000,000)
	Units Sold		500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000
	Unit Sale Price		$                     8.00	$              8.00	$              8.00	$              8.00	$              8.00	$              8.00	$              8.00	$              8.00	$              8.00	$              8.00
	Total Revenue		$          4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000	$   4,000,000
	Variable cost per Unit		$                           4	$                    4	$                    4	$                    4	$                    4	$                    4	$                    4	$                    4	$                    4	$                    4
	Total Variable Cost		$        (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)	$ (2,000,000)
	Depreciation		$            (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)	$     (900,000)
	EBIT		$          1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000	$   1,100,000
	EBITDA (Add back Depreciation)		$          2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000
	Free Cash Flow	$ (9,000,000)	$          2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000	$   2,000,000
	Discount Factor @ 12%	1.00	0.89	0.80	0.71	0.64	0.57	0.51	0.45	0.40	0.36	0.32
	NPV of cash flows	$ (9,000,000)	$          1,785,714	$   1,594,388	$   1,423,560	$   1,271,036	$   1,134,854	$   1,013,262	$       904,698	$       807,766	$       721,220	$       643,946	$      (777,185)
	NPV of Expected Case	$     (777,185)	Negative
b	Sensitivity Analysis	Units Sold	NPV
	Pessimistic	400,000.00	$ (2,421,748.28)
	Expected	500,000.00	$      (777,185.35)
	Optimistic	700,000.00	$    2,511,940.51