Question

We are evaluating a project that costs $800,000, has an eight-year life, and has 20% salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 70,000 units per year. Price per unit is $40, variable cost per unit is $30, and fixed costs are $725,000 per year. The tax rate is 40 percent, and we require a 15 percent return on this project. a) Calculate the accounting break-even point. b) Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales. c) What is the sensitivity of OCF to changes in the variable cost figure? Explain what your answer tells you about a $1 decrease in estimated variable costs. d) Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within +- 15 percent. Calculate the best-case and worst-case NPV figures

Answer 1

Part (a)

Accounting break even quantity, Q then

Profits = 0

i.e Sales - Variable cost - fixed cost - depreciation = 0

Hence, 40Q - 30Q -725,000 - 800,000 / 8 = 0

Hence, accounting break even quantity, Q = 825,000/10 = 82,500

Part (b) to (d) appear side by side in the table below:

		Part (b)	Part (b)	Part (c )	Part (d)	Part (d)
		Base Case	Sensitivity		Best	Worst
Capital cost		800,000.00	800,000.00	800,000.00	800,000.00	800,000.00
Life		8.00	8.00	8.00	8.00	8.00
Sale Price		40.00	40.00	40.00	46.00	34.00
Volume		70,000.00	69,500.00	70,000.00	80,500.00	59,500.00
Variable cost		30.00	30.00	29.00	25.50	34.50
Fixed cost		725,000.00	725,000.00	725,000.00	616,250.00	833,750.00
Annual depreciation		100,000.00	100,000.00	100,000.00	100,000.00	100,000.00
Salvage value		160,000.00	160,000.00	160,000.00	160,000.00	160,000.00
EBIT		-125,000.00	-130,000.00	-55,000.00	934,000.00	-963,500.00
Taxes		-50,000.00	-52,000.00	-22,000.00	373,600.00	-385,400.00
NOPAT		-75,000.00	-78,000.00	-33,000.00	560,400.00	-578,100.00
OCF		25,000.00	22,000.00	67,000.00	660,400.00	-478,100.00
Post tax salvage value		96,000.00	96,000.00	96,000.00	96,000.00	96,000.00
Discount rate		15%	15%	15%	15%	15%
NPV		-656,434.39	-669,896.36	-467,966.89	2,194,809.69	-2,914,005.84
IRR		-15.04%

Excel formula snapshot: