Question

Q. A new project is being considered and the data is given below. The asset has a 3-year tax life, would be depreciated on a straight-line basis over the project's 3-year life, and would have a zero salvage value after Year 3. Operating working capital change would be of $1000. Revenues and other operating costs will be constant over the project's life. If the units decline by 45% from the expected level, find the change in NPV.
Investment cost $60,000
Units 2,800
Price/Unit $25.00
Fixed costs $10,000
V cost/unit $5.375
Annual depreciation $20,000
WACC 10.0%
Tax rate 40.0%

Solve using a financial calculator. Do it manually. Do not use Excel!

Answer 1

~ Operating Cash Flow For NPV Calculation:

Sales (2800 x $25)	$70,000
Less: Variable Cost (2800 x $5.375)	$15,050
Less: Fixed Cost	$10,000
Less: Depreciation	$20,000
Profit Before Taxes	$24,950
Less: Taxes (40%)	$9980
Net Income	$14,970
Add back: Depreciation	$20,000
Less: Change in Working Capital	$1,000
Net Operating Cash Flow	$33970

~ NPV in financial calculator:

CF 0 = -$60,000

CF 1 to 3 = $33970

I/Y = 10%

NPV = $24,478.36

~ Operating Cash Flow if Units Decline By 45%:

Sales (1540 x $25)	$38,500
Less: Variable Cost (1540 x $5.375)	$8,277.50
Less: Fixed Cost	$10,000
Less: Depreciation	$20,000
Profit Before Taxes	$222.50
Less: Taxes (40%)	$89
Net Income	$133.50
Add back: Depreciation	$20,000
Less: Change in Working Capital	$1,000
Net Operating Cash Flow	$19133.50

~ NPV if Units Decline by 45%:

CF 0 = -$60,000

CF 1 to 3 = $19133.50

I/Y = 10%

NPV = $12,417.82

~ Change in NPV

= NPV if Units Decline - NPV of Original Expectations

= $12,417.82 - $24,478.36

= -$12,060.54

Therefore, Change in NPV = -$12,060.54 (Decrease of $12,060.54)