Question

We are evaluating a project that costs $500,000, 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 50,000 units per year. Price per unit is $40, variable cost per unit is $25, and fixed costs are $600,000 per year. The tax rate is 35 percent, and we require a return of 12 percent on this project.

   

a-1	Calculate the accounting break-even point. (Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32.)

  

Break-even point

44166 units

   

a-2	What is the degree of operating leverage at the accounting break-even point? (Do not round intermediate calculations. Round your answer to 3 decimal places, e.g., 32.161.)

   

DOL 10.6

   

b-1	Calculate the base-case cash flow and NPV. (Do not round intermediate calculations. Round your cash flow answer to the nearest whole number, e.g., 32. Round your NPV answer to 2 decimal places, e.g., 32.16.)

  

Cash flow	$119375
NPV	$93007.25

b-2	What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

ΔNPV/ΔQ

$ _________

  

c.	What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to the nearest whole number, e.g., 32. )

  

ΔOCF/ΔVC

$ ________

Answer 1

Accounting break-even = (FC + Depreciation) / (P - VC) = (600,000 + 62,500) / (40 - 25) = 44,167

At break-even point, DOL = 1 + FC / OCF = 1 + 662,500 / 62,500 = 11.6

	0	1 - 8
Investment	-500,000
Sales		2,000,000
VC		-1,250,000
FC		-600,000
Depreciation		-62,500
EBT		87,500
Tax		-30,625
Net Income		56,875
Cash Flow	-500,000	119,375
NPV	$1,093,012.00

Cash Flow = Net Income + Depreciation

NPV = PV of cash flows from year 1 to 8 - Initial Investment.

PV can be calculated using PV function in excel or calculator

N = 8, I/Y = 12%, PMT = 119,375, FV = 0

=> Compute PV = $1,593,012

NPV = 1,593,012 - 500,000 = $1,093,012

ΔNPV/ΔQ is the change in NPV when Q is changed by 1 unit.

If Q = 50,001 then NPV = $1,093,060.43 => ΔNPV/ΔQ = 1,093,060.43 - 1,093,012 = $48.43

ΔOCF/ΔVC is the change in OCF when VC is changed by 1 unit.

If VC = $26 per unit, then OCF = $86,875 => ΔOCF/ΔVC = 86,875 - 119,375 = -32,500