Question

1. A 10-year steel pipe-producing project requires $60 million in upfront investment (all in depreciable assets), $24 million of which is borrowed capital at an interest rate of 8.00% per year. The expected pipe sales are 1,600,000 pipes per year. The expected price per pipe is $156 and the variable cost is $129 per unit. The fixed costs excluding depreciation are expected to be $22 million per year for ten years. The upfront investment will be depreciated on a straight line basis for the 10-year useful life of the project to $8 million book value. The expected salvage value of the assets is $10 million. The tax rate is 30% and the RRR applicable to the project is 16%.
   1. Calculate the accounting and cash break-even points.
   2. Calculate the DOL, DFL, and DCL (Do not use the equations and do your own change in sales).
   3. Calculate the NPV breakeven annual free cash flow for the project.
   4. Calculate the NPV break-even point (Q_b).

Please show all calculations clearly and draw decision trees where necessary.

Answer 1

1 .Accounting BEP = Fixed cost/ Contribution

FC = 1,344,000( after tax interest cost) + 21'000'000+ 4'200'000( After tax depreciation).

= 26'544'000/27

= 983'111pipes

Cash BEP = FC- Depreciation/ contribution

= 22'344'000/27

= 827'556 pipes

2. DOL = Contribution/ EBIT

= 43'200'000/15'200'000

= 2.84

DFL = EBIT/ EBT

=15'200'000/13'280'000

= 1.14

DCL = contribution/ EBT

= 43'200'000/13'280'000 = 3.25.

3. Annual free cashflow

Contribution- FC- 70% tax rate

Contribution - 43'200'000

FC. ( 22'000'000)

Depreciation-. ( 6'000'000)

Interest expenses-. (1'920'000)

Total=. 13'280'000

= 13'280'000 × 70%= 9'296'000

Add Depreciation tax shield = 1'800'000

Annual cashflow = 11'096'000.

4. Total discounted cash flow= 11'096'000 × 4 .83. = 53'593'680

Add. salvage

Last year book value 8'000'000

Salvage value 10'000'000

Profit = 2'000'000 = 2'000'000× 70%

= 1'400'000× .23 = 317'357.

Total discounted inflow = 53'593'680+ 317'357

= 53'911'037

NPV = 53'911'037 - 60'000'000 = ( 6'088'963)

Bep npv point= ( 6'088'963)/156

= 39'032 pipes ( NPV is negative)