Question

Scenario Analysis. Automatic Transmissions, Inc., has the following estimates for its new gear assembly project; price = $1,070 per unit; variable cost = $290 per unit; fixed costs = $4.8 million; quantity = 70,000 units. Suppose the company believes all of its estimates are accurate only to within + / - 15 percent. What values should the company use for the four variables given here when it performs the best –case scenario analysis? What about the worst-case scenario? Hint: Use the top part only of the NPV template. Also review the scenario analysis of the presentation within this folder.

Scenario

Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-died to last longer). Pappy's paid $120,000 for a marketing survey to determine the viability of the product. It is felt that Potato pet will generate sales of $725,000 per year. The fixed costs associated with this will be $187,000 per year, and variable costs wil amount to 20 percent of sales. The equipment necessary for production of the Potato pet will cost $835,000 and will be depreicated in a straight-line manner for the four years of the product life (as with all fads, it is felt that sales will end quickly). This is the only intial cost for the production.. Pappy's is in a 40% tax bracket and has a required return of 13 percent. Calculate the payback period, NPV and IRR.

Answer 1

Best Case:

Compute the expected selling price, using the equation as shown below:

Expected selling price = Current price*(1 + Increase)

                                     = $1,070*(1 + 0.15)

                                     = $1,230.50

Hence, the expected selling price is $1,230.50.

Compute the expected variable cost, using the equation as shown below:

Expected variable cost = Current cost*(1 – Decrease)

                                     = $290*(1 - 0.15)

                                     = $246.50

Hence, the expected variable cost is $246.50.

Compute the expected fixed cost, using the equation as shown below:

Expected fixed cost = Fixed cost*(1 – Decrease)

                                 = $4,800,000*(1 – 0.15)

                               = $4,080,000

Hence, the expected fixed cost is $4,080,000.

Compute the expected quantity, using the equation as shown below:

Expected quantity = Quantity*(1 + Increase)

                              = 70,000*(1 + 0.15)

                              = 80,500

Hence, the expected quantity is 80,500.

Worst Case:

Compute the expected selling price, using the equation as shown below:

Expected selling price = Current price*(1 – Decrease)

                                     = $1,070*(1 - 0.15)

                                     = $909.50

Hence, the expected selling price is $909.50.

Compute the expected variable cost, using the equation as shown below:

Expected variable cost = Current cost*(1 + Increase)

                                     = $290*(1 + 0.15)

                                     = $333.50

Hence, the expected variable cost is $333.50.

Compute the expected fixed cost, using the equation as shown below:

Expected fixed cost = Fixed cost*(1 + Increase)

                                 = $4,800,000*(1 + 0.15)

                               = $5,520,000

Hence, the expected fixed cost is $5,520,000.

Compute the expected quantity, using the equation as shown below:

Expected quantity = Quantity*(1 - Decrease)

                              = 70,000*(1 - 0.15)

                              = 59,500

Hence, the expected quantity is 59,500.