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We are evaluating a project that costs $874,800, has a nine-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 85,000 units per year. Price per unit is $55, variable cost per unit is $39, and fixed costs are $765,000 per year. The tax rate is 24 percent, and we require a return of 11 percent on this project. Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent.

Calculate the best-case and worst-case NPV figures

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jepessoa

Answer:

best case scenario:

project outlay = $874,800

yearly cash flows:

  • projected sales = 85,000 x 110% = 93,500
  • sales price = $55 x 110% = $60.50
  • variable costs = $39 x 90% = $35.10
  • fixed costs = $765,000 x 90% = $688,500
  • depreciation costs = $874,800 / 9 = $97,200
  • tax rate = 24%

yearly cash flows = {[(93,500 x $60.50) - (93,500 x $35.10) - $688,500 - $97,200] x (1 - 24%)} + $97,200 = $1,304,992

using a financial calculator, NPV = $6,351,002.73

worst case scenario:

project outlay = $874,800

yearly cash flows:

  • projected sales = 85,000 x 90% = 76,500
  • sales price = $55 x 90% = $49.50
  • variable costs = $39 x 110% = $42.90
  • fixed costs = $765,000 x 110% = $841,500
  • depreciation costs = $874,800 / 9 = $97,200
  • tax rate = 24%

yearly cash flows = {[(76,500 x $49.50) - (76,500 x $42.90) - $841,500 - $97,200] x (1 - 24%)} + $97,200 = -$232,488

using a financial calculator, NPV = -$2,071,211.79