We are evaluating a project that costs $831,000, has a life of 15 years, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 149,000 units per year. Price per unit is $40, variable cost per unit is $27, and fixed costs are $840,141 per year. The tax rate is 23 percent, and we require a return of 13 percent on this project.

1a. Calculate the accounting break-even point.

1b. What is the degree of operating leverage at the accounting break-even point?

2a. Calculate the base-case cash flow.

2b. Calculate the NPV.

2c. What is the sensitivity of NPV to changes in the quantity sold?

2d. What your answer tells you about a 500-unit decrease in the quantity sold?

3a. What is the sensitivity of OCF to changes in the variable cost figure?

3b. How much will OCF change if variable costs decrease by $1?

2.

A proposed project has fixed costs of $37,000 per year. The operating cash flow at 17,000 units is $67,000.

a. Ignoring the effect of taxes, what is the degree of operating leverage?

b. If units sold rise from 17,000 to 17,300, what will be the increase in operating cash flow?

c. What is the new degree of operating leverage?

3.

McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $600 per set and have a variable cost of $300 per set. The company has spent $173,000 for a marketing study that determined the company will sell 56,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 15,000 sets of its high-priced clubs. The high-priced clubs sell at $900 and have variable costs of $600. The company will also increase sales of its cheap clubs by 10,000 sets. The cheap clubs sell for $400 and have variable costs of $200 per set. The fixed costs each year will be $6,912,000. The company has also spent $968,000 on research and development for the new clubs. The plant and equipment required will cost $19,200,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $910,000 that will be returned at the end of the project. The tax rate is 24 percent, and the cost of capital is 14 percent.

McGilla Golf would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold.

a. What is the sensitivity of the NPV to changes in the price of the new club?

b. What is the sensitivity of the NPV to changes in the quantity sold?