We are evaluating a project that costs $1,350,000, has a six-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 87,000 units per year. Price per unit is $34.25, variable cost per unit is $20.50, and fixed costs are $750,000 per year. The tax rate is 35 percent, and we require an 11 percent return on this project.
a. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales.
b. What is the sensitivity of OCF to changes in the variable cost figure? Explain what your answer tells you about a $1 decrease in estimated variable costs.