Question

Suppose that a company is considering an investment in a new product with a 5-year horizon (product will be sold for 5 years). The upfront investment is $1 million and it is assumed to depreciate on a straight-line basis for 5 years, with no residual value. Fixed costs are assumed to be $50,000 per year. The company estimates the variable cost per unit (v) to be $5 and expects to sell each unit for $15. There are no taxes and the required rate of return is 8% per year.

The company estimates that they will be able to sell 32,000 units during the year under normal circumstances (base case), but they believe that actual sales could be 10% lower than 32,000 (worst case) or 10% higher than 32,000 (best case).

Base Case NPV =
Worst Case NPV =  
Best Case NPV =

Answer 1

		Base Case						Worst Case							Best Case
Year	0	1	2	3	4	5		0	1	2	3	4	5		0	1	2	3	4	5
Initial Investment	($1,000,000)							($1,000,000)							($1,000,000)
Number of unit sold		32000							28800							35200
Revenue from sales(@$15/unit)		$480,000	$480,000	$480,000	$480,000	$480,000			$432,000	$432,000	$432,000	$432,000	$432,000			$528,000	$528,000	$528,000	$528,000	$528,000
Fixed cost		($50,000)	($50,000)	($50,000)	($50,000)	($50,000)			($50,000)	($50,000)	($50,000)	($50,000)	($50,000)			($50,000)	($50,000)	($50,000)	($50,000)	($50,000)
Variable Cost		($160,000)	($160,000)	($160,000)	($160,000)	($160,000)			($144,000)	($144,000)	($144,000)	($144,000)	($144,000)			($176,000)	($176,000)	($176,000)	($176,000)	($176,000)
Cash from Operation		$270,000	$270,000	$270,000	$270,000	$270,000			$238,000	$238,000	$238,000	$238,000	$238,000			$302,000	$302,000	$302,000	$302,000	$302,000
Depreciation		($200,000)	($200,000)	($200,000)	($200,000)	($200,000)			($200,000)	($200,000)	($200,000)	($200,000)	($200,000)			($200,000)	($200,000)	($200,000)	($200,000)	($200,000)
Net Cash flow from operation		$70,000	$70,000	$70,000	$70,000	$70,000			$38,000	$38,000	$38,000	$38,000	$38,000			$102,000	$102,000	$102,000	$102,000	$102,000
Tax		0	0	0	0	0			0	0	0	0	0			0	0	0	0	0
Cash flow after tax		$70,000	$70,000	$70,000	$70,000	$70,000			$38,000	$38,000	$38,000	$38,000	$38,000			$102,000	$102,000	$102,000	$102,000	$102,000
Plus depreciation		$200,000	$200,000	$200,000	$200,000	$200,000			$200,000	$200,000	$200,000	$200,000	$200,000			$200,000	$200,000	$200,000	$200,000	$200,000
Cash flow from operation		$270,000	$270,000	$270,000	$270,000	$270,000			$238,000	$238,000	$238,000	$238,000	$238,000			$302,000	$302,000	$302,000	$302,000	$302,000
Rate of return	8%
PV( cash flow from Operation)	($1,000,000)	$250,000	$231,481	$214,335	$198,458	$183,757		($1,000,000)	$220,370	$204,047	$188,932	$174,937	$161,979		($1,000,000)	$279,630	$258,916	$239,737	$221,979	$205,536
NPV	$78,032							($49,735)							$205,798