Question
DrillOng Sdn Bhd has developed a powerful new hand drill that would be used for woodwork and carpentry activities. It would cost $1 million to
DrillOng Sdn Bhd has developed a powerful new hand drill that would be used for woodwork and carpentry activities. It would cost $1 million to buy the equipment necessary to manufacture the drills, and it would require net operating working capital equal to 10% of sales. It would take 1 year to buy the required equipment and set up operations, and the project would have a life of 5 years. If the project is undertaken, it must be continued for the entire 5 years.
The firm believes it could sell 6,000 units per year. The drills would sell for $250 per unit, and DrillOng believes that variable costs would amount to $180 per unit. The companys fixed costs would be $110,000 at Year 1 and would increase with inflation. After the first year, the sales price and variable costs will also increase at the inflation rate of 3%.
The equipment would be depreciated over a 5-year period, using the straight-line method. The salvage value of the equipment at the end of the projects 5-year life is $50,000. The company however estimated the machine can be sold as scrap for RM60,000. The corporate tax rate is 25%.
The projects returns are expected to be highly correlated with returns on the firms other assets. The cost of capital is 12%.
- Conduct a scenario analysis. Assume that the best-case condition is with the sales price increase by 10%, number of units sold 6,200 units, variable costs per unit and fixed cost increase 5% from the base-case value. The worst-case condition, with increase in the variable and fixed cost by 25% and with no change in the unit sales and unit price from the base value. The best-case condition, worst-case condition, and the base case are assumed to have an equal probability. What would be the projects coefficient of variation NPV?
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