Question

1. A 10-year steel pipe-producing project requires $66million in upfront investment (all in depreciable assets). The expected price per pipe is $64 and the variable cost is $24 per widget. The fixed costs excluding depreciation are expected to be $14 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 $6 million book value. The expected salvage value of the assets is $14 million. The tax rate is 25% and the WACC applicable to the project is 14%

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

b. Calculate the NPV break-even point

Answer 1

NPV breakeven refers to the point at which NPV is 0 .

a.

Let the no of units be X.

NPV Cash flow =[( Selling price - variable cost )* no of units - fixed cost - depreciation ] * ( 1 - tax rate ) + depreciation

= [ ( 64 -24)*X - 14 - 5.2 ] * ( 1 - 0.25) + 5.2

= [ 40X -19.2]0.75 + 5.2

= 30X - 19.60

b. Now let equate the breakeven cashflows and initial investment

66 = ( 30X -19.60) * [ 1 - 1.14^-10]/0.14 + 14/1.14^10

66 = ( 30X -19.60 ) * 7.3026 + 3.7764

66 = 219.08X - 143.13 +3.7764

66 +143.13 -3.7764 = 219.08X

205.35 = 219.08X

205000000 / 219.08 =X = 937359.62

NPV breakeven point = 937359.62