Caravan Corp. is contemplating a new widget manufacturing plant with the following details:

1. The project will require an initial investment (in year 0) in machinery worth $100,000.

2. The project life is three years. At the end, the machine will be sold for $10,000.

3. The machine will be depreciated over 3 years using the straight line method.

4. The project will require net working capital of $15,000 at the end of year 1. The requirement will increase by $5,000 in the second year and remain there for the rest of the project. At the end of the project it will be freed up.

5. Widgets cost $15 per unit in the first year and can be sold for $50 per unit. In the second and third years, widgets cost $17 but can be sold for $55.

6. There are additional fixed costs of $10,000 during each year of operation.

7. Due to a special government incentive, there Caravan pays no tax.

8. The relevant discount rate is 10%.

(i) Compute the breakeven number of units assuming that the same number of units is sold each year.

(ii) How much does NPV increase for one extra unit sold in each year? Assume all other figures including net working capital are unaffected.

(iii) The analysts at Caravan estimate that the market demand will be between 1,400 and 1,500 units. Should the project be undertaken? Make any reasonable assumptions.

Answer rating: 100% (QA)

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