1. Melbourne Metal is considering becoming a supplier of transmission housings. It would require buying a new forge that would cost $125,000 (including all setup costs) and is expected to last five years. Let the asset life be the life of the project.

Melbourne Metal does a best guess (Base) study of their costs and revenues. They anticipate setting their price at p = $50 per unit and they estimate the annual demand is q = 2,500 10p. Variable costs (labour, materials, etc.) are estimated to be $15 per unit. Total fixed costs (excluding depreciation of the forge) is estimated to be $10,000 per year.

Melbourne Metal uses the double declining balance method for depreciation. The book balance at the start of year 1 is the $125,000. The depreciation in a year is a fixed percentage 0 < < 1 of the beginning of year book balance where the book balance at the beginning of year n is the book balance at the end of year n 1. The book balance at the end of year n, Bn = Bn-1 depreciation that year. With the double declining balance method, the depreciation rate = 2 where N is the life of the project. The salvage value is assumed to the book balance at the end of the project.

The tax rate is 40%. The MARR is 15%.

a. Set up an Income Statement and calculate annual net income for each year of the project. (15)

b. Set up a Statement of Cash Flows to calculate the net cash flows for the project. (10)

c. Find the net present value NPV of the project. (3)

d. Re-calculate NPV assuming the unit price is $10 higher and then $10 lower. Recalculate NPV assuming the average variable cost AVC is $10 higher and then $10 lower. Is the NPV of the project more sensitive to the unit price or the average variable cost? Explain. Note: Dont do the % deviation I did in class since these are dollar unit changes just change the unit price or AVC directly. (10)

e. At what unit price will the project breakeven? (Dont do this by hand five years is too complicated. If you dont have Excel, try various prices until you get NPV close enough to zero).