Question

The initial cost of the project is $160,000 and it has a 5-year life, with a salvage value of zero. Depreciation is straight-line; the required return is 12% and the tax rate is 30%.

                                 Base Case           Lower Bound           Upper Bound

Unit Sales                  5,000                     5,500                            6,000

Price/unit                   $ 80                       $ 77                               $ 85

Var. cost/unit             $ 60                       $ 57                             $ 65

Fixed cost/year         $ 50,000             $ 46,000                            $60,000

Use the five-year annuity factor of 3.605 @ 12%, the Base Case NPV is:

Answer 1

Base Case NPV = 783

Calculations

Step 1 - Initial Investment

A. Initial Investment (Year 0)
Cost of Machine	160,000
Total Outlow (A)	160,000

Step 2 - Calculation of depreciation

Depreciation = 160000 / 5 = 32000

Step 3 - Calculation of annual cash flow and present value

Particulars	Cash Flow
Sales (5000*80)	400000
Less variable cost (5000*60)	300000
Less Fixed Cost	50000
Operating Profit	50000
Less : Depreciation	32000
Earning Before Tax	18000
Less : Tax @ 30%	5400
Earning After Tax	12600
Add Back : Depreciation	32000
Cash flow After Tax (CFAT)	44600

Present Value of CFAT

CFAT	44600
five year annuity factor	3.605
PV of CFAT (B)	160783

Step 4 Caclulation of NPV

NPV = PV of CFAT - Initital Investment

NPV = 160783 - 160000 = 783

Base case NPV = 783