Question

We are evaluating a project that costs $520,000, has a life of 6 years, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 73,000 units per year. Price per unit is $45, variable cost per unit is $30, and fixed costs are $840,000 per year. The tax rate is 21 percent and we require a return of 15 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

  

Calculate the best-case and worst-case NPV figures. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Initial Investment = $520,000
Useful Life = 6 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $520,000 / 6
Annual Depreciation = $86,666.67

Best Case:

Annual OCF = [(Price per unit - Variable Cost per unit) * Sales Volume - Fixed Costs] * (1 - tax) + tax * Depreciation
Annual OCF = [($49.50 - $27.00) * 80,300 - $756,000] * (1 - 0.21) + 0.21 * $86,666.67
Annual OCF = $1,050,750 * 0.79 + 0.21 * $86,666.67
Annual OCF = $848,292.50

NPV = -$520,000 + $848,292.50 * PVIFA(15%, 6)
NPV = -$520,000 + $848,292.50 * 3.78448
NPV = $2,690,346.00

Worst Case:

Annual OCF = [(Price per unit - Variable Cost per unit) * Sales Volume - Fixed Costs] * (1 - tax) + tax * Depreciation
Annual OCF = [($40.50 - $33.00) * 65,700 - $924,000] * (1 - 0.21) + 0.21 * $86,666.67
Annual OCF = -$431,250 * 0.79 + 0.21 * $86,666.67
Annual OCF = -$322,487.50

NPV = -$520,000 - $322,487.50 * PVIFA(15%, 6)
NPV = -$520,000 - $322,487.50 * 3.78448
NPV = -$1,740,447.49