Question

You are considering a new product launch. The project will cost $574,000, have a five-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $16,000, variable cost per unit will be $12,500, and fixed costs will be $179,000 per year. The required return on the project is 13.5 percent, and the relevant tax rate is 35 percent. Based on your experience, you think the unit sales, variable cost, fixed cost projections given here are probably accurate within plus or minus 3%. What is the worst case NPV? (show your work not in excel)

Answer 1

Initial Investment = $574,000
Useful Life = 5 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $574,000 / 5
Annual Depreciation = $114,800

Worst Case:

Sales Volume = 160 * (1 - 0.03)
Sales Volume = 155

Selling Price per unit = $16,000

Variable Cost per unit = $12,500 * (1 + 0.03)
Variable Cost per unit = $12,875

Fixed Costs = $179,000 * (1 + 0.03)
Fixed Costs = $184,370

Annual Operating Cash Flow = [(Selling Price per unit - Variable Cost per unit) * Sales Volume - Fixed Costs)] * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = [($16,000 - $12,875) * 155 - $184,370] * (1 - 0.35) + 0.35 * $114,800
Annual Operating Cash Flow = $300,005 * 0.65 + 0.35 * $114,800
Annual Operating Cash Flow = $235,183.25

Required return = 13.50%

NPV = -$574,000 + $235,183.25/1.135 + $235,183.25/1.135^2 + $235,183.25/1.135^3 + $235,183.25/1.135^4 + $235,183.25/1.135^5
NPV = -$574,000 + $235,183.25 * (1 - (1/1.135)^5) / 0.135
NPV = -$574,000 + $817,201.27
NPV = $243,201.27

Worst Case NPV is $243,201.27