Question

Q5. Case Study: Assume that are the financial manager of a company, which is considering a potential project with a new product that is expected to sell for an average price of $22 per unit and the company expects it can sell 350 000 unit per year at this price for a period of 4 years. Launching this project will require purchase of a $2 000 000 equipment that has residual value in four years of $200 000 and adding $ 600 000 in working capital which is expected to be fully retrieved at the end of the project. Other information is available below:
Depreciation method: straight line
Variable cost per unit: $11
Cash fixed costs per year $350 000
Discount rate: 10%
Tax Rate: 30%
Do an analysis with cash flows of the project to determine the sensitivity of the project NPV with the following changes in the value drivers and provide your results in (a) relevant tables:
Unit sales decrease by 10%
Price per unit decreases by 10%
Variable cost per unit increases 10%
Cash fixed cost per year increases by 10%

Answer 1

Sensitivity analysis:

Scenario	NPV	Deviation in NPV from orignial scenario	% depletion
Original	6140513
Unit sale decreases by 10%	5286234	-854279	13.91%
Price per unit decreases by 10%	2894254	-3246259	52.87%
Variable cost per unit increases 10%	5286234	-854279	13.91%
Cash fixed cost per year increases by 10%	6062851	-77662	1.26%

Calculation of original NPV

Sales (350000 * 22)	7700000
Less: Variable cost (350000 * 11)	-3850000
Less: Fixed cost	-350000
Less: Depreciation [(2000000 - 200000) / 4]	-450000
Profit before tax	3050000
Less: Tax @ 30%	-915000
Profit after tax	2135000
Add: Depreciation	450000
Cash flow after tax	2585000

	0	1	2	3	4
Initial investment	-2000000
Working capital	-600000
Cash flow after tax		2585000	2585000	2585000	2585000
Working capital released					600000
Residual value					200000
Net cash flows	-2600000	2585000	2585000	2585000	3385000
PVF @ 10%	1	0.9091	0.8264	0.7513	0.6830
Present value	-2600000	2350000	2136364	1942149	2312001
NPV					6140513

Calculation of NPV when unit sales decrease by 10%

Sales (315000 * 22)	6930000
Less: Variable cost (315000 * 11)	-3465000
Less: Fixed cost	-350000
Less: Depreciation [(2000000 - 200000) / 4]	-450000
Profit before tax	2665000
Less: Tax @ 30%	-799500
Profit after tax	1865500
Add: Depreciation	450000
Cash flow after tax	2315500

	0	1	2	3	4
Initial investment	-2000000
Working capital	-600000
Cash flow after tax		2315500	2315500	2315500	2315500
Working capital released					600000
Residual value					200000
Net cash flows	-2600000	2315500	2315500	2315500	3115500
PVF @ 10%	1	0.9091	0.8264	0.7513	0.6830
Present value	-2600000	2105000	1913636	1739669	2127928
NPV					5286234

Calculation of NPV when price per unit decrease by 10%

Sales (350000 * 19.8)	6237000
Less: Variable cost (350000 * 11)	-3850000
Less: Fixed cost	-350000
Less: Depreciation [(2000000 - 200000) / 4]	-450000
Profit before tax	1587000
Less: Tax @ 30%	-476100
Profit after tax	1110900
Add: Depreciation	450000
Cash flow after tax	1560900

	0	1	2	3	4
Initial investment	-2000000
Working capital	-600000
Cash flow after tax		1560900	1560900	1560900	1560900
Working capital released					600000
Residual value					200000
Net cash flows	-2600000	1560900	1560900	1560900	2360900
PVF @ 10%	1	0.9091	0.8264	0.7513	0.6830
Present value	-2600000	1419000	1290000	1172727	1612526
NPV					2894254

Calculation of NPV when variable cost per unit increases 10%

Sales (350000 * 22)	7700000
Less: Variable cost (350000 * 12.1)	-4235000
Less: Fixed cost	-350000
Less: Depreciation [(2000000 - 200000) / 4]	-450000
Profit before tax	2665000
Less: Tax @ 30%	-799500
Profit after tax	1865500
Add: Depreciation	450000
Cash flow after tax	2315500

	0	1	2	3	4
Initial investment	-2000000
Working capital	-600000
Cash flow after tax		2315500	2315500	2315500	2315500
Working capital released					600000
Residual value					200000
Net cash flows	-2600000	2315500	2315500	2315500	3115500
PVF @ 10%	1	0.9091	0.8264	0.7513	0.6830
Present value	-2600000	2105000	1913636	1739669	2127928
NPV					5286234

Calculation of NPV when cash fixed cost per year increases by 10%

Sales (350000 * 22)	7700000
Less: Variable cost (350000 * 11)	-3850000
Less: Fixed cost	-385000
Less: Depreciation [(2000000 - 200000) / 4]	-450000
Profit before tax	3015000
Less: Tax @ 30%	-904500
Profit after tax	2110500
Add: Depreciation	450000
Cash flow after tax	2560500

	0	1	2	3	4
Initial investment	-2000000
Working capital	-600000
Cash flow after tax		2560500	2560500	2560500	2560500
Working capital released					600000
Residual value					200000
Net cash flows	-2600000	2560500	2560500	2560500	3360500
PVF @ 10%	1	0.9091	0.8264	0.7513	0.6830
Present value	-2600000	2327727	2116116	1923742	2295267
NPV					6062851