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Wednesday, 9 July 2014

You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.

You are considering a new product launch. The project will cost $2,200,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 150 units per year; price per unit will be $29,000, variable cost per unit will be $17,500, and fixed costs will be $590,000 per year. The required return on the project is 12 percent, and the relevant tax rate is 34 percent.
  
a.
Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (Negative amount should be indicated by a minus sign. Round your NPV answers to 2 decimal places. (e.g., 32.16))
 
  Scenario Unit Sales Variable Cost Fixed Costs NPV
  Base $ $  $   
  Best     
  Worst     

 
b.
Evaluate the sensitivity of your base-case NPV to changes in fixed costs. (Negative amount should be indicated by a minus sign. Round your answer to 3 decimal places. (e.g., 32.161))
 
  ΔNPV/ΔFC $  
  
c.
What is the cash break-even level of output for this project (ignoring taxes)? (Round your answer to 2 decimal places. (e.g., 32.16))
  
  Cash break-even  
  
d-1
What is the accounting break-even level of output for this project? (Round your answer to 2 decimal places. (e.g., 32.16))
  
  Accounting break-even  
 
d-2
What is the degree of operating leverage at the accounting break-even point? (Round your answer to 3 decimal places. (e.g., 32.161))
  
  Degree of operating leverage  


Explanation:

In each of the following cases, calculate the accounting break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))

In each of the following cases, calculate the accounting  break-even and the cash break-even points. Ignore any tax effects in calculating the cash break-even. (Round your answers to 2 decimal places. (e.g., 32.16))
   
 Case Unit Price Unit Variable Cost Fixed Costs Depreciation
1 $ 3,370 $ 2,675 $ 8,120,000 $ 3,060,000
2 146 81 78,000 350,000
3   31     7     3,700     860  



Case Accounting break-even Cash break-even
1    
2    
3    



Explanation:
The cash break-even equation is:
 
QC = FC/(P – v)
 
And the accounting break-even equation is:
QA = (FC + D)/(P – v)
  
Using these equations, we find the following cash and accounting break-even points:
  
a. QC = $8,120,000/($3,370 – 2,675) QA = ($8,120,000 + 3,060,000)/($3,370 – 2,675)
  QC = 11,683.45 QA = 16,086.33
  
b. QC = $78,000/($146 – 81) QA = ($78,000 + 350,000)/($146 – 81)
  QC = 1,200.00 QA = 6,584.62
 
c. QC = $3,700/($31 – 7) QA = ($3,700 + 860)/($31 – 7)
  QC = 154.17 QA = 190.00

We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

We are evaluating a project that costs $690,000, has a five-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 71,000 units per year. Price per unit is $75, variable cost per unit is $50, and fixed costs are $790,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project.
   
a-1
Calculate the accounting break-even point.
 
  Break-even point  units
   
a-2
What is the degree of operating leverage at the accountin g break-even point? (Round your answer to 3 decimal places. (e.g., 32.161))
   
  DOL  
   
b-1
Calculate the base-case cash flow and NPV. (Round your NPV answer to 2 decimal places. (e.g., 32.16))
 
   
  Cash flow   $  
  NPV $  

 
b-2
What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your answer to 3 decimal places. (e.g., 32.161))
 
  ΔNPV/ΔQ $  
  
c. What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign.)
  
  ΔOCF/ΔVC $  


Explanation: a.
To calculate the accounting breakeven OCF, we first need to find the depreciation for each year. The depreciation is:
 
Depreciation = $690,000/5
Depreciation = $138,000 per year
   
And the accounting breakeven is:
 
QA = ($790,000 + 138,000)/($75 – 50)
QA = 37,120 units
   
To calculate the accounting breakeven, we must realize at this point (and only this point), the OCF is equal to depreciation. So, the DOL at the accounting breakeven is:
 
DOL = 1 + FC/OCF = 1 + FC/D
DOL = 1 + [$790,000)/$138,000)]
DOL = 6.725
 
b. 
We will use the tax shield approach to calculate the OCF. The OCF is:
  
OCFbase = [(P – v)Q – FC](1 – T) + TD
OCFbase = [($75 – 50)(71,000) – $790,000](0.65) + 0.35($138,000)
OCFbase = $688,550
 
Now we can calculate the NPV using our base-case projections. There is no salvage value or NWC, so the NPV is:
 
NPVbase = –$690,000 + $688,550(PVIFA15%,5)
NPVbase = $1,618,126.39
  
To calculate the sensitivity of the NPV to changes in the quantity sold, we will calculate the NPV at a different quantity. We will use sales of 76,000 units. The NPV at this sales level is:
 
OCFnew = [($75 – 50)(76,000) – $790,000](0.65) + 0.35($138,000)
OCFnew = $769,800
  
And the NPV is:
 
NPVnew = –$690,000 + $769,800(PVIFA15%,5)
NPVnew = $1,890,488.99
  
So, the change in NPV for every unit change in sales is:
 
ΔNPV/ΔS = ($1,618,126.39 – 1,890,488.99)/(71,000 – 76,000)
ΔNPV/ΔS = +$54.473
  
If sales were to drop by 500 units, then NPV would drop by:
 
NPV drop = $54.473(500) = $27,236.26
 
You may wonder why we chose 76,000 units. Because it doesn’t matter! Whatever sales number we use, when we calculate the change in NPV per unit sold, the ratio will be the same.
 
c.
To find out how sensitive OCF is to a change in variable costs, we will compute the OCF at a variable cost of $51. Again, the number we choose to use here is irrelevant: We will get the same ratio of OCF to a one dollar change in variable cost no matter what variable cost we use. So, using the tax shield approach, the OCF at a variable cost of $51 is:
 
OCFnew = [($75 – 51)(71,000) – 790,000](0.65) + 0.35($138,000)
OCFnew = $642,400

So, the change in OCF for a $1 change in variable costs is:
 
ΔOCF/ΔVC = ($688,550 – 642,400)/($50 – 51)
ΔOCF/ΔVC = –$46,150
 
If variable costs decrease by $1 then, OCF would increase by $46,150

Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $2,500 per unit; variable costs = $500 per unit; fixed costs = $5.1 million; quantity = 80,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?
 
Scenario Units Sales Unit Price Unit
Variable cost
Fixed Costs
  Base    $    $     $  
  Best            
  Worst            



Explanation:

K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.

K-Too Everwear Corporation can manufacture mountain climbing shoes for $43.03 per pair in variable raw material costs and $25.45 per pair in variable labor expense. The shoes sell for $140 per pair. Last year, production was 110,000 pairs. Fixed costs were $1,150,000.
 
What were total production costs?
 
  Total production cost $  
 
What is the marginal cost per pair? (Round your answer to 2 decimal places. (e.g., 32.16))

  Marginal cost per pair $  

What is the average cost per pair? (Round your answer to 2 decimal places. (e.g., 32.16))
 
  Average cost per pair $  
   
If the company is considering a one-time order for an extra 9,000 pairs, what is the minimum acceptable total revenue from the order?
  
  Total revenue $  


Explanation: