Ex-C

Your company is considering the development of a new product. In evaluating the proposed project, your company has collected the following information:

• The company estimates that the project will last for four years.

• The company will need to purchase new machinery that has an up-front cost of $200

  million. The machinery will be depreciated on a straight-line basis to zero over the

  four years.

• The project will require a $25 million investment in inventory at the beginning of the

  project. At the end of the project, the working capital will be completely recovered.

• The company estimates that sales of the new product will be $250 million each of the

  next four years.

• Variable costs are expected to be 40% of revenue each year.

• Fixed costs are $80 million each year

• The company expects to sell the machinery for $30 million at the end of the project.

• The company tax rate is 30%, and the projects required rate of return is 10%.

1. a) What is the effect of changes on NPV for a change in Revenue, Fixed and Variable costs?

2. b) Imagine the risk you have estimated for the project is incorrect. What is the effect of this on the projects NPV?

Ex-D

Using the same data as in Ex-C, the company has further broken up the areas of revenue and costs:

• Of the $250 million in revenue, the breakdown of the revenue into its components are: o $150 million in widgets

  o $75 million in glow in the dark sunglasses

  o $25 million in wall hanging mouse pads

• In the same vein, the costs associated with the project are broken into the following

  portions: o 25% of the revenue is due to raw materials o 10% of the revenue is due to marketing and advertising o 5% of the revenue is due to maintenance of the project

  What is the effect of an individual change in all of the variables associated with the project on NPV?

  This is a question that you may want to do after the workshop for your specific revision or understanding.