Question

P11-6 Scenario Analysis [LO2]

We are evaluating a project that costs $741,000, has an ten-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 118,000 units per year. Price per unit is $36, variable cost per unit is $23, and fixed costs are $749,151 per year. The tax rate is 33 percent, and we require a 12 percent return on this project. The projections given for price, quantity, variable costs, and fixed costs are all accurate to within +/- 15 percent.

  

Required:
(a)	Calculate the best-case NPV. (Do not round your intermediate calculations.)

  

(b)	Calculate the worst-case NPV.

Answer 1

Cost of Project = $741,000
Useful Life = 10 years

Annual Depreciation = $741,000 / 10
Annual Depreciation = $74,100

Answer a.

Annual OCF = [(Selling Price-Variable Cost)*Quantity - Fixed Cost]*(1-tax) + tax*Depreciation
Annual OCF = [($41.40-$19.55)*135,700 - $636,778.35]*(1-0.33) + 0.33*$74,100
Annual OCF = $2,328,266.65*0.67 + 0.33*$74,100
Annual OCF = $1,584,391.66

NPV = -$741,000 + $1,584,391.66 * PVA of $1 (12%, 10)
NPV = -$741,000 + $1,584,391.66 * 5.6502
NPV = $8,211,129.76

Best-case NPV is $8,211,129.76

Answer b.

Annual OCF = [(Selling Price-Variable Cost)*Quantity - Fixed Cost]*(1-tax) + tax*Depreciation
Annual OCF = [($30.60-$26.45)*100,300 - $861,523.65]*(1-0.33) + 0.33*$74,100
Annual OCF = -$445,278.65*0.67 + 0.33*$74,100
Annual OCF = -$273,883.70

NPV = -$741,000 - $273,833.70 * PVA of $1 (12%, 10)
NPV = -$741,000 - $273,833.70 * 5.6502
NPV = -$2,288,215.17

Worst-case NPV is -$2,288,215.17