Question

1.Emperor’s Clothes Fashions can invest $5.14 million in a new plant for producing invisible makeup. The plant has an expected life of five years, and expected sales are 6.14 million jars of makeup a year. Fixed costs are $2.35 million a year, and variable costs are $1.35 per jar. The product will be priced at $2.35 per jar. The plant will be depreciated straight-line over five years to a salvage value of zero. The opportunity cost of capital is 10%, and the tax rate is 40%.

1. What is project NPV under these base-case assumptions?
2. What is NPV if variable costs turn out to be $1.55 per jar?
3. What is NPV if fixed costs turn out to be $1.85 million per year?
4. At what price per jar would project NPV equal zero?

2. You are considering a proposal to produce and market a new sluffing machine. The most likely outcomes for the project are as follows:

Expected sales: 55,000 units per year

Unit price: $100

Variable cost: $60

Fixed cost: $1,650,000

The project will last for 10 years and requires an initial investment of $1.52 million, which will be depreciated straight-line over the project life to a final value of zero. The firm’s tax rate is 30%, and the required rate of return is 12%.

However, you recognize that some of these estimates are subject to error. Sales could fall 30% below expectations for the life of the project and, if that happens, the unit price would probably be only $90. The good news is that fixed costs could be as low as $1,100,000, and variable costs would decline in proportion to sales.

a. What is project NPV if all variables are as expected?

b. What is NPV in the worst-case scenario?

Answer 1

Solution 1 (a), 1(b), 1(c)

Solution 1(d)

Solution 2(a), 2(b):