Question

We are evaluating a project that costs $660,000, has a five-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 69,000 units per year. Price per unit is $58, variable cost per unit is $38, and fixed costs are $660,000 per year. The tax rate is 35 percent, and we require a return of 12 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.

Answer 1

Solution

In Best case price and quanity increase by 10% cost decrease by 10% & Vice Versa for worst case

	Original	Best	Worst
Price Per Unit	58	63.8	52.2
Sales Quantity	69000	75900	62100
Variable cost per unit	38	34.2	41.8
Fixed cost	660000	594000	726000
Operating Cash Flow		1120416	-5904
NPV		3379099.68	-681283.92

WORKINGS

Operating Cash Flow : (Sales - Cost )*(1- Tax)+ (Depreciation *Tax)

Best case : (4842420 -(2595780+594000)*(1-.35)+(132000*.35)

(4842420-3189780)*.65+46200

1120416

Worst Case

(3241620-(2595780+726000)*(1-..35)+(132000*.35)

(3241620-3321780)*.65+46200 (-5904)

Now will show how to arrive at value for sales ,cost and depreciation

Sales : Multiply the Sales quantity with price

Best case : 75900*63.8 = 4842420

Worst Case : 62100 *52.2 = 3241620

Variable cost multiply the Sales quantity with cost per unit

Best Case : 75900 *34.2 = 2595780

Worst Case : 62100*41.8 = 2595780

Depreciation : 660000/5 = 132000

Note for NPV Calculation

Best case

1120416 * PVIFA12,5 – 660000

        =3379099.68

Worst Case

NPV =

=-5904 * PVIFA12,5 – 660000

        = -681283.92