Problem 3

A new product will be launched in the near future. This project will require an investment that costs $1,700,000. The investment has an economic life of 4 years with no residual value. The depreciation method used is straight-line method. The unit sales are projected at 190 units per year at a price of $18,000. Variable costs are $11,200 and fixed costs are $410,000. Required return of 12%, tax rate of 35%.

a)Based on previous experience, it is believed that the price (P), projected costs (FC and VC), and unit sales (Q) have an accurate probability of 10%. What is the upper and lower for these components? What is the base-case NPV? What is the best-case and worst-case NPV?

b)Evaluate the sensitivity of the base-case NPV from changes in fixed costs!

c)Considering tax, how is the cash break-even level of this project?

d)Considering tax, what is the accounting break-even level of this project?

e)Ignoring tax, what is the degree of operating leverage when accounting breaks even level? Interpret!