Concept explainers
Project Analysis You are considering a new product launch. The project will cost $760,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 420 units per year; price per unit will be $17,200; variable cost per unit will be $14,300; and fixed costs will be $640,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 35 percent.
- a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case
NPV ? What are the best-case and worst-case scenarios? - b. Evaluate the sensitivity of your base-case NPV to changes in fixed costs.
- c. What is the accounting break-even level of output for this project?
a)
To determine: Best-case net present value.
Introduction:
The difference between the present value of cash outflow and the present value of cash inflow is termed as net present value.
Explanation of Solution
Given information:
The project has the cost of $760,000 with no salvage value and 4 years of economic cycle. Depreciation is on straight line method. The sales are at 420 units, the price per unit is $17,200, the variable cost per unit is $14,300, and the fixed cost is$640,000 per year. The required rate of return is 15% and the rate of tax is35%.
The variable cost, unit price, fixed cost projections are accurate within ±10%.
The formula to calculate the net present value:
The formula to calculate the operating cash flow:
Compute the upper and lower bounds of the above projections:
In the best-case, when the cost decreases, the unit sales will increase; whereas in the worst-case, when the cost increases, the unit sales will decrease.
Scenario |
Base case | Upper case | Lower case |
Unit sales | 420 | 462 | 378 |
Variable costs | $14,300 | $12,870 | $15,730 |
Fixed costs | $640,000 | $576,000 | $704,000 |
Note: Refer excel for the above table.
Compute the base-case operating cash flow:
Hence, the base-case operating cash flow is$442,200.
Compute the base-case net present value:
Note: The increase in the operating cash flow at the present value interest factor of annuity at 15% for 4 years is 2.85498.
Compute the base-case net present value:
Hence, the base-case net present value is$502,472.15.
Compute the worst–case operating cash flow:
Hence, the worst-case operating cash flow is−$29,921.
Compute the worse-case net present value:
Note: The increase in the operating cash flow at the present value interest factor of annuity at 15% for 4 years is 2.85498.
Hence, the worse-case net present value is −$845,423.85.
Compute the best-case operating cash flow:
Hence, the best-case operating cash flow is $992,399.
Compute the best-case net present value:
Hence, the best-case net present value is $2,073,279.29.
b)
To determine: The sensitivity of base-case net present value to the changes in fixed costs.
Answer to Problem 13QP
Solution: Therefore, the net present value falls by −$1.856 for an increase in every dollar.
Explanation of Solution
Given information:
The project has the cost of $760,000 with no salvage value and 4 years of economic cycle. Depreciation is on straight line method. The sales are at 420 units, the price per unit is $17,200, the variable cost per unit is $14,300, and the fixed cost is $640,000 per year. The required rate of return is 15% and the rate of tax is 35%.
Compute the base-case operating cash flow to the changes in fixed costs:
Note: To compute the sensitivity of base-case net present value to the changes in fixed costs, the levels of fixed cost need to increase to another level. Assume it to be $650,000.
Hence, the base-caseoperating cash flow is $435,700.
Compute the base-case net present value:
Hence, the base-case net present value is $483,914.78.
Compute the sensitivity of net present value to the changes in fixed costs:
Hence, the sensitivity of net present value to the changes in fixed cost is −$1.856.
Therefore, the net present value falls by −$1.856for an increase in every dollar.
c)
To determine: The accounting break-even level of output.
Introduction:
Accounting break-even point refers to a point where the company faces zero profits.
Answer to Problem 13QP
Solution: The accounting break-even point is 286.21 units.
Explanation of Solution
Given information:
The project has a cost of $760,000 with no salvage value and 4 years of economic cycle. Depreciation is on straight line method. The sales are at 420 units, the price per unit is $17,200, the variable cost per unit is $14,300, and the fixed cost is $640,000 per year. The required rate of return is 15% and the rate of tax is 35%.
The variable cost, unit price, fixed cost projections are accurate within ±10%.
The formula to calculate the accounting break-even level:
Compute the accounting break-even level:
Hence, the accounting break-even point is286.21 units.
Want to see more full solutions like this?
Chapter 7 Solutions
UPENN: LOOSE LEAF CORP.FIN W/CONNECT
- Friedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.arrow_forwardGina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?arrow_forwardMarkoff Products is considering two competing projects, but only one will be selected. Project A requires an initial investment of $42,000 and is expected to generate future cash flows of $6,000 for each of the next 50 years. Project B requires an initial investment of $210,000 and will generate $30,000 for each of the next 10 years. If Markoff requires a payback of 8 years or less, which project should it select based on payback periods?arrow_forward
- You are considering a new product launch. The project will cost $2,050,000, have a four- 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 $18.900, variable cost per unit will be $12,200, and fixed costs will be $600.000 per year. The required return on the project is 12 percent, and the relevant tax rate is 24 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within 10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.) Scenario C. Base Best Worst Unit Sales b. ANPV/AFC c. Cash break-even Variable…arrow_forwardYou are considering a new product launch. The project will cost $2,050,000, have a 4-year life, and have no salvage value; depreciation is straight-line to O. Sales are projected at 170 units per year; price per unit will be $26,000; variable cost per unit will be $17,000; and fixed costs will be $520,000 per year. The required return on the project is 15%, and the relevant tax rate is 35%. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10%. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Negative answers should be indicated by a minus sign. Do not round intermediate calculations. Round the final NPV answers to 2 decimal places. Omit $ sign in your response.) Scenario Base Best Worst ▸ Unit Sales $ Variable Cost $ $ $ units Fixed Costs $ $ $ NPV b. Evaluate the sensitivity of your base-case NPV to changes…arrow_forwardYou are considering a new product launch. The project will cost $1,500,000, have a four- year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 160 units per year; price per unit will be $18,000, variable cost per unit will be $10,500, and fixed costs will be $450,000 per year. The required return on the project is 10 percent, and the relevant tax rate is 22 percent. a-1. The unit sales, variable cost, and fixed cost projections given above are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) a-2. What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g.,…arrow_forward
- You are considering a new product launch. The project will cost $900,000, have a 5-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 290 units per year; price per unit will be $15,895, variable cost per unit will be $11,700, and fixed costs will be $595,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 22 percent. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within £10 percent. a. What are the best-case and worst-case NPVS with these projections? Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16. b. What is the base-case NPV? Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. c. What is the sensitivity of your base-case NPV to changes in fixed costs? Note: A…arrow_forwardYou are considering a new product launch. The project will cost $1,750,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 220 units per year; price per unit will be $20,000, variable cost per unit will be $13,000, and fixed costs will be $500,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 22 percent. a-1.The unit sales, variable cost, and fixed cost projections given above are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.)a-2.What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g.,…arrow_forwardYou are considering a new product launch. The project will cost $2,050,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 170 units per year; price per unit will be $26,000, variable cost per unit will be $16,000, and fixed costs will be $560,000 per year. The required return on the project is 15 percent, and the relevant tax rate is 23 percent. a-1. The unit sales, variable cost, and fixed cost projections given above are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) a-2. What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g.,…arrow_forward
- You are considering a new product launch. The project will cost $2,350,000, have a four- year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 330 units per year; price per unit will be $19,600, variable cost per unit will be $14,000, and fixed costs will be $720,000 per year. The required return on the project Is 10 percent, and the relevant tax rate is 21 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within 10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round Intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.) Scenario Base Best Worst Unit Sales 330 363 297 Answer is complete and correct.…arrow_forwardYou are considering a new product launch. The project will cost $2,050,000, have a four-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 $18,900, variable cost per unit will be $12,200, and fixed costs will be $600,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 24 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.) b. Evaluate the sensitivity of your base-case NPV to…arrow_forwardYou are considering a new product launch. The project will cost $2,375,000, have a four- year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 340 units per year; price per unit will be $19,900, variable cost per unit will be $14,150, and fixed costs will be $730,000 per year. The required return on the project is 11 percent, and the relevant tax rate is 22 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.) Scenario Unit Sales Base 340 S Best Worst 374 306 Variable Cost b. C. Evaluate…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTCornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
- Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax CollegeManagerial Accounting: The Cornerstone of Busines...AccountingISBN:9781337115773Author:Maryanne M. Mowen, Don R. Hansen, Dan L. HeitgerPublisher:Cengage Learning