Question

A 10-year widget-producing project requires $36 million in upfront investment (all in depreciable assets), 30% of which is borrowed capital at an interest rate of 6% per year. The expected widget sales are 1,000,000 widgets per year. The expected price per widget is $24 and the variable cost is $12 per widget. The fixed costs excluding depreciation are expected to be $6 million per year for ten years. The upfront investment will be depreciated on a straight line basis for the 10-year useful life of the project to zero book value. The expected salvage value of the assets is $8 million. The tax rate is 40% and the WACC applicable to the project is 15%.

A. Calculate the NPV breakeven annual cash flow for the project.

B. Calculate the NPV break-even point

Answer 1

A. To calculate NPV breakeven annual cash flow, expenses should be equal to the incomes.

So, total annual expenses of widget producing project is:-

Profit per unit of sales = 24 - 12 = $ 12 per unit

Now, profit per $1 of sales = Sales - Variable cost.

Variable cost is 50% of Sales.

So, profit per dollar of sales = 1 (Sales) - 0.5 (VC) = $ 0.5

Fixed cost = 6,000,000

Borrowed interest expense = 36,000,000 * 30% * 6% = 648,000

Depreciation Expense = (36,000,000 - 8,000,000) / 10 = 2,800,000

NPV breakeven annual cash flow = Fixed cost + Interest Expense + Depreciation / Profit per dollar of sales

= (6,000,000 + 648,000 + 2,800,000) / 0.5

= $ 18,896,000