Question

A corporation needs a machine that costs $1 million and net working capital of $100,000 for an investment project. Assume the depreciation is straight-line to zero over the 5 year life of the machine. The project has a 4 year life and the machine will have an expected market value of $300,000 at the end of the project. Sales are expected to be 70,000 units per year. Price per unit is expected to be $50, variable costs per unit is expected to be $34 and fixed costs are expected to be $800,000 per year. The tax rate is expected to be 25% and the company requires a 10% return on this project. What is the numerical break even quantity? How much does a $2 decrease in the projected price per unit change NPV?

Answer 1

Base case NPV is calculated as below :

Operating cash flow (OCF) each year = income after tax + depreciation

In year 4, the entire working capital investment is recovered.

profit on sale of equipment at end of year 4 = sale price - book value

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value - tax on profit on sale of equipment   

NPV is calculated using NPV function in Excel

NPV is $175,391

Breakeven sales quantity is the sales quantity at which NPV is zero. Breakeven sales quantity is calculated using GoalSeek in Excel

Breakeven sales quantity is 65,389 units

if the price per unit decreases by $2, NPV decreases to -$157,445