Question
You are considering a new product launch. The project will cost $680,000, have a four-year life, and have no salvage value; depreciation is straight-line to
You are considering a new product launch. The project will cost $680,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 100 units per year, price per unit will be $19,000, variable cost per unit will be $14,000, and fixed costs will be $150,000 per year. The required return on the project is 15%, and the relevant tax rate is 35%. Ignore the half-year rule for accounting for depreciation.
a.Calculate the following six numbers for this project. Round your answers to two decimal places.
(i) NPV
(ii) Profitability Index (PI)
(iii) Payback period (in years)
(iv) Discounted payback period (in years)
(v)Internal Rate of Return (IRR in %)
(vi) Average Accounting Return (AAR in %)
Hint: Net Income = {[(Price - variable cost)*Quantity Sold] - Fixed Costs - Depreciation} * (1 - Tax rate)
b.Evaluate the sensitivity of the NPV, PI, Payback period, Discounted payback period, AAR, and IRR to a 10% variation in the number of units sold per year. Ensure that you interpret your answers in words.
Hint #1: For example, for the NPV, increase the quantity sold by 10% and re-calculate the NPV. Then calculate the percentage change of this new NPV over the base case NPV from part (a). Repeat the process for a 10% decrease in quantity sold.
Hint #2: You must perform the process in Hint #1 for each of the six items in part (a). Note that IRR and AAR are already rates of returns. You do not have to calculate the percentage changes over the base case numbers for IRR and AAR. Instead, simply calculate the difference between the new numbers and the base case numbers for IRR and AAR.
Hint #3: It may be easier to perform these calculations in a spreadsheet. If you opt to do these calculations in a spreadsheet, ensure that you copy and paste the spreadsheet into your Word document.
You are considering a project that will supply an automobile production facility with 35,000 tonnes of machine screws annually for five years. To get the project started, you will need an initial investment of $1,500,000 in threading equipment. The project will last for five years. The accounting department estimates that annual fixed costs will be $300,000 and that variable costs should be $200 per tonne. The CCA rate for threading equipment is 20%. Accounting estimates a salvage value of $500,000 after costs of dismantling. The marketing department estimates that the auto makers will accept the contract at a selling price of $250 per tonne. The engineering department estimates you will need an initial net working capital investment of $450,000. You require a 15% return and face a marginal tax rate of 38% on this project.
a.What is the NPV for this project? Should you pursue this project?
b.Suppose you believe that the accounting department's initial cost and salvage projections are accurate only to within 15%; the marketing department's price estimate is accurate only to within 10%; and the engineering department's net working capital estimate is accurate only to within 5%. What is your worst-case scenario for this project? Your best-case scenario?
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