Question

Tank Co. is evaluating a project that costs $120000, has a 5-year life.

Assume that depreciation is prime-cost to zero salvage value over the 5-years, and the equipment

can be sold for $6,000 at the end of year 5. The average discount rate for such project is 10 per

cent on such projects. The individual tax rate is 15 per cent and corporate tax rate is 30 per cent.

It is projected that they will sell 12000 units per year. Price per unit is $12, variable cost per unit

is $3 and fixed costs are $21000 per year.

a. Calculate the accounting break-even point and cash break-even point. (5’)

b. What is the degree of operating leverage at the accounting breakeven point? (5’)

c. What is the estimated NPV for the project, and should Tank accept the project? (10’)

d. Suppose the projections given are all accurate to within 10 per cent except for sales

volume, which is only accurate to within 20 per cent. Calculate the NPV under the best

and worst cases. (20’)

Answer 1

a)

Cost	1,20,000.00
Life	5.00
Salvage Value	Zero
Depreciation	=(120000)/5	24,000.00
Fixed Cost	21,000.00
Quantity	12,000.00
Selling Price	12.00	1,44,000.00
Variable Cost	3.00	36,000.00
Contribution	=12-3	9.00
Accounting break even point	=Fixed cost/contribution
	=21000/9	2,333.33
Cash break even point	=(Fixed cost-depreciation))/contribution
	=(21000-24000)/9	-333.33

b)

Degree of operating leverage	=(sales – variable costs)/(sales – variable costs– fixed costs​)
	=(144000-36000)/(144000-36000-21000)
	=1.241379

c)

Estimated NPV for the project
Year	Cashflow	PVF	PV
0	-1,20,000.00	1.00	-120000
1	68,100.00	0.91	61902.9
2	68,100.00	0.83	56250.6
3	68,100.00	0.75	51143.1
4	68,100.00	0.68	46512.3
5	72,300.00	0.62	44898.3
			1,40,707.20
*Cashflow	=(Operating Income-depreciation)*tax rate +depreciation
	=((144000-36000-21000-24000)*.7)+24000
	=68100
*Cashflow 5th year	=Cashflow+(Selling value*(1-taxrate))
	=68100+6000*.7
	=72300
Accept the project since NPV is positive

d)

Estimated NPV for the project
Year	Cashflow	PVF	PV
0	-1,20,000.00	1.00	-120000
1	68,100.00	0.83	56727.3
2	68,100.00	0.69	47261.4
3	68,100.00	0.58	39429.9
4	68,100.00	0.48	32824.2
5	72,300.00	0.40	29064.6
			85,307.40