Question

4. You are considering a new product launch. The project will cost $1,800,000, have a three-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 210 units per year; price per unit will be $15,000, variable cost per unit will be $9,500, and fixed costs will be $550,000 per year. The required return on the project is 14%, and the relevant tax rate is 35%. What is the sensitivity of NPV to FC?

Answer 1

$3,095,136.86

Step-by-step explanation:

Initial Investment = $2,125,000

Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life

Annual Depreciation = $2,125,000 / 4

Annual Depreciation = $531,250

Base Case:

Annual OCF = [(Price per unit - Variable Cost per unit) * Sales Quantity - Fixed Cost] * (1 - Tax Rate) + Tax Rate * Depreciation

Annual OCF=[(18,900-12,650)*240-630,000]*(1-0.22)+0.22*531.250

Annual OCF=$795,475

NPV=-2,125,000+795,475*PVA of 1(9%, 4)

NPV=-2,125,000+795,475*3.23972

NPV=$452,116.27

Worst Case:

Annual OCF = [(Price per unit - Variable Cost per unit) * Sales Quantity - Fixed Cost] * (1 - Tax Rate) + Tax Rate * Depreciation

Annual OCF=[(17,010-13,915)*216-693,000]*(1-0.22)+0.22*531.250

Annual OCF=$97,780.60

NPV=-2,125,000+97,780.60*PVA of 1(9%,4)

NPV=$1,808,218.23

BEST CASE:

Annual OCF = [(Price per unit - Variable Cost per unit) * Sales Quantity - Fixed Cost] * (1 - Tax Rate) + Tax Rate * Depreciation

Annual OCF=[20,790-11,385)*254-567,000]*(1-0.22)+0.22*531,250

Annual OCF=1,915,920*0.78+0.22*531,250

Annual OCF=$1,611,292.60

NPV=-2,125,000+1,611,292.60*PVA of 1(9%,4)

NPV=$3,095,136.86