ABC Inc is considering the launch of a new product line. The initial cost for this 5-year
Question:
ABC Inc is considering the launch of a new product line. The initial cost for this 5-year project is estimated at £3,000,000 for fixed assets that are not expected to have any salvage value. The firm uses the straight-line depreciation approach to depreciate its fixed assets. Demand for the products is forecast to be 500 units per year and the firm expects to sell the product for £8,000 per unit. The variable expenses for producing this output are estimated to be £4,000 per unit and the fixed costs are expected to be £200,000 per year. The required return is 16.5 percent and the relevant tax rate is 30 percent. The project will not have any impact on working capital requirements.
Based on your experience, you think the unit sales and price are accurate within a ±2 percent range while costs may vary by ±3 percent.
(i) What is the sensitivity of the baseline operating cash flow to changes in the sales price? Interpret your answer
(ii) What are the operating cash flows under the worst-case scenario?