Question
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
Ex-C
Your company is considering the development of a new product. In evaluating the proposed project, your company has collected the following information:
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The company estimates that the project will last for four years.
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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.
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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.
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The company estimates that sales of the new product will be $250 million each of the
next four years.
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Variable costs are expected to be 40% of revenue each year.
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Fixed costs are $80 million each year
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The company expects to sell the machinery for $30 million at the end of the project.
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The company tax rate is 30%, and the projects required rate of return is 10%.
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a) What is the effect of changes on NPV for a change in Revenue, Fixed and Variable costs?
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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:
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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
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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.
Ex-E
The company you work for is setting up a new data communications centre. The project has the following estimates:
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Sale price of a unit: $150
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Variable cost per unit: $90
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Fixed Costs: $1,500,000
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Project Cost: $9,000,000
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Life of Project: 3 years
Assume straight line depreciation
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a) What is the accounting break-even point in units?
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b) What is the accounting break-even point in revenue?
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c) What is the cash break-even point in units?
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