Question

We are evaluating a project that costs $734,000, 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 109,000 units per year. Price per unit is $44, variable cost per unit is $26, and fixed costs are $742,808 per year. The tax rate is 37 percent, and we require a 18 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 18 percent.

Required:
(a)	Calculate the best-case NPV.

  

(b)	Calculate the worst-case NPV.

Answer 1

Initial Investment = $734,000
Useful Life = 8 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $734,000 / 8
Annual Depreciation = $91,750

Answer a.

OCF = [(Price per unit-Variable Cost per unit)*Sales Volume - Fixed Costs]*(1-tax) + tax*Depreciation
OCF = [($51.92-$21.32)*128,620 - $609,102.56]*(1-0.37) + 0.37*$91,750
OCF = $3,326,669.44*0.63 + 0.37*$91,750
OCF = $2,129,749.25

NPV = -$734,000 + $2,129,749.25 * PVIFA(18%, 8)
NPV = -$734,000 + $2,129,749.25 * (1 - (1/1.18)^8) / 0.18
NPV = $7,950,192.61

Answer b.

OCF = [(Price per unit-Variable Cost per unit)*Sales Volume - Fixed Costs]*(1-tax) + tax*Depreciation
OCF = [($36.08-$30.68)*89,380 - $876,513.44]*(1-0.37) + 0.37*$91,750
OCF = -$393,861.44*0.63 + 0.37*$91,750
OCF = -$214,185.21

NPV = -$734,000 - $214,185.21 * PVIFA(18%, 8)
NPV = -$734,000 - $214,185.21 * (1 - (1/1.18)^8) / 0.18
NPV = -$1,607,354.28