Question

Brutech Corporation is considering whether or not to launch its new product, a kioskfor checking in medical patients at doctor’s offices. Marketing research is confidentthe kioskwill sell 1,300units per year, but the finance department is also evaluating the risks that unit sales and other key forecast variables might pose if the initial data differs from reality.

In the Base Case, the selling price on the 1,300 units will be $2,100 per kiosk. Variable costsper unitwill be $1,300, and fixed costs will be $200,000 per year. The company pays a tax rate of 34%. The total investment needed to undertake the projectis $2,500,000. This amount (I) will be depreciated straight-line to zero over the five-year life of the equipment. The salvage value is zero, and there are no working capital consequences. Brutechhas a 25percent required return on new projects.

Theproject has a zero NPV when the present value of the operating cash flows equals the $2,500,000 investment. Because the cash flow is the same each year, we can solve for the unknown amount by viewing it as an ordinary annuity. Sincethe formula for calculating PVIFAr,Nis [1-(1+r)-N]/r, the PVIFA25%,5= [1-(1.25)-5]/0.25= (1-.326780) / 0.25 = .672320 / 0.25 = 2.6893TheOCF* can /be determined as follows:OCF*= $2,500,000/2.6893

                            Lower Bound                     Upper Bound

Unit Sales                  1,200                                 1,400

Sales price per unit       $1,800                          $2,400

Variable cost per unit     $1,100                        $1,500

Fixed Costs                 $150,000                      $250,000

1-Assuming the Base Case, what effect would a sales increaseof 100 unitshave on the operating cash flow?

Answer 1

Present value of OCF with 1300 units is

Year	Units	Selling Price	Cost price	Fixed Cost	Depreciation	Depreciation * tax Rate	Cash Flow
1	1300	2100	1300	200000	500000	170000	670000
2	1300	2100	1300	200000	500000	170000	670000
3	1300	2100	1300	200000	500000	170000	670000
4	1300	2100	1300	200000	500000	170000	670000
5	1300	2100	1300	200000	500000	170000	670000
						Present Value of Operating Cash Flow	18,01,818

Present Value of OCF with 1400 units is

Year	Units	Selling Price	Cost price	Fixed Cost	Depreciation	Depreciation * tax Rate	Cash Flow
1	1400	2100	1300	200000	500000	170000	750000
2	1400	2100	1300	200000	500000	170000	750000
3	1400	2100	1300	200000	500000	170000	750000
4	1400	2100	1300	200000	500000	170000	750000
5	1400	2100	1300	200000	500000	170000	750000
						Present Value of Operating Cash Flow	20,16,960