Question

Global Corporation is considering the launch of a new product.

Asset acquisition is $1,400,000 with a four-year life (straight-line depreciation) and no salvage value. You estimate sales at 180 units/year with a $16,000/unit selling price. Variable costs are expected to be $9,800/unit, and fixed costs will be $430,000 annually. Your project requires a 12% rate of return, and the company’s tax rate is 35%.
Based on prior experience, you believe unit sales, variable costs, and fixed cost projections to be accurate to within +/- 10%.
a. What are the upper and lower bounds for these projections?
Lower Bounds –
Upper Bounds –
b. What is the base-case NPV?
c. What are the best and worst case IRR scenarios?

Answer 1

To calculate the upper and lower bounds for the projections, you should consider a 10% increase and decrease in sales and variable costs. The base-case NPV can be calculated by discounting the cash flows at the required rate of return. The best and worst case IRR scenarios can be found by finding the discount rate that makes the NPV equal to zero for the upper and lower bounds of the projections.

Step-by-step explanation:

To calculate the upper and lower bounds for the projections, we need to calculate the upper and lower values for unit sales and variable costs. If we assume a 10% increase in sales, the upper bound for unit sales would be 180 + 10% = 198 units/year. If we assume a 10% decrease in sales, the lower bound would be 180 - 10% = 162 units/year. Similarly, if we assume a 10% increase in variable costs, the upper bound for variable costs would be $9,800 + 10% = $10,780/unit. If we assume a 10% decrease in variable costs, the lower bound would be $9,800 - 10% = $8,820/unit.

The base-case NPV can be calculated by discounting the cash flows (sales - variable costs - fixed costs - depreciation) at the 12% rate of return. The best and worst case IRR scenarios can be calculated by finding the discount rate that makes the NPV equal to zero for the upper and lower bounds of the projections.