Question

We are evaluating a project that costs $800,000, has an eight-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 60,000 units per year. Price per unit is $40, variable cost per unit is $20, and fixed costs are $800,000 per year. The tax rate is 35 percent, and we require a return of 10 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

For best case unit sales and price are increased by 10%, while variable costs and fixed costs are reduced by 10%.

For worst case, unit sales and price are decreased by 10%, while variable costs and fixed costs are increased by 10%.

	Unit Sales	Price	Variable costs	Fixed costs
Base	60000.00	40.00	20.00	800000.00
Best	66000.00	44.00	18.00	720000.00
Worst	54000.00	36.00	22.00	880000.00

OCF = (Sales - Costs)*(1-tax) + Tax*depreciaiton

Best case = ((44-18)*66000 - 720000)*(1-0.35) + 0.35*800000/8 = 682400

Worst case = ((36-12)*54000 - 880000)*(1-0.35) + 0.35*800000/8 = -45600

NPV:

Best case = -800000 + 682400/(1+0.1)^1 + 682400/(1+0.1)^2 + 682400/(1+0.1)^3 + 682400/(1+0.1)^4 + 682400/(1+0.1)^5 + 682400/(1+0.1)^6 + 682400/(1+0.1)^7 + 682400/(1+0.1)^8 = $2840553.64

Worst case = -800000 - 45600/(1+0.1)^1 - 45600/(1+0.1)^2 - 45600/(1+0.1)^3 - 45600/(1+0.1)^4 - 45600/(1+0.1)^5 - 45600/(1+0.1)^6 - 45600/(1+0.1)^7 - 45600/(1+0.1)^8 = -$1043272.63