The Buffalo Snow Shoe Company is considering manufacturing radial snow shoes, which are more durable and offer better traction. Buffalo estimates that the investment in manufacturing equipment will cost $250,000 and will have a 10-year economic life. Buffalo will depreciate the equipment on a straight-line basis to a $0 estimated salvage value over a 10-year period. The estimated selling price of each pair of shoes will be $50. Buffalo anticipates that it can sell 5,000 pairs a year at this price. Unit production and selling costs (exclusive of depreciation) will be about $25. The firm’s marginal tax rate is 40 percent. A cost of capital of 12 percent is thought to be appropriate to analyze a project of this type. Buffalo has decided to perform a sensitivity analysis of the project before making a decision.
a. Compute the expected net present value of this project.
b. Buffalo’s president does not believe that 5,000 pairs of the new snow shoes can be sold at a $50 price. He estimates that a maximum of 3,000 pairs will be sold at this price. How does the change in the estimated sales volume influence the net present value of the project?