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Suppose that a company is considering an investment in a new product with a 5-year horizon...

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Finance

Suppose that a company is considering an investment in a newproduct with a 5-year horizon (product will be sold for 5 years).The upfront investment is $1 million and it is assumed todepreciate on a straight-line basis for 5 years, with no residualvalue. Fixed costs are assumed to be $50,000 per year. The companyestimates the variable cost per unit (v) to be $5 and expects tosell each unit for $15. There are no taxes and the required rate ofreturn is 8% per year.

The company estimates that they will be able to sell 32,000 unitsduring the year under normal circumstances (base case), but theybelieve that actual sales could be 10% lower than 32,000 (worstcase) or 10% higher than 32,000 (best case).

Base Case NPV =
Worst Case NPV =  
Best Case NPV =

Answer & Explanation Solved by verified expert
3.7 Ratings (315 Votes)

Base Case Worst Case Best Case
Year 0 1 2 3 4 5 0 1 2 3 4 5 0 1 2 3 4 5
Initial Investment ($1,000,000) ($1,000,000) ($1,000,000)
Number of unit sold 32000 28800 35200
Revenue from sales(@$15/unit) $480,000 $480,000 $480,000 $480,000 $480,000 $432,000 $432,000 $432,000 $432,000 $432,000 $528,000 $528,000 $528,000 $528,000 $528,000
Fixed cost ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000) ($50,000)
Variable Cost ($160,000) ($160,000) ($160,000) ($160,000) ($160,000) ($144,000) ($144,000) ($144,000) ($144,000) ($144,000) ($176,000) ($176,000) ($176,000) ($176,000) ($176,000)
Cash from Operation $270,000 $270,000 $270,000 $270,000 $270,000 $238,000 $238,000 $238,000 $238,000 $238,000 $302,000 $302,000 $302,000 $302,000 $302,000
Depreciation ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000) ($200,000)
Net Cash flow from operation $70,000 $70,000 $70,000 $70,000 $70,000 $38,000 $38,000 $38,000 $38,000 $38,000 $102,000 $102,000 $102,000 $102,000 $102,000
Tax 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Cash flow after tax $70,000 $70,000 $70,000 $70,000 $70,000 $38,000 $38,000 $38,000 $38,000 $38,000 $102,000 $102,000 $102,000 $102,000 $102,000
Plus depreciation $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000 $200,000
Cash flow from operation $270,000 $270,000 $270,000 $270,000 $270,000 $238,000 $238,000 $238,000 $238,000 $238,000 $302,000 $302,000 $302,000 $302,000 $302,000
Rate of return 8%
PV( cash flow from Operation) ($1,000,000) $250,000 $231,481 $214,335 $198,458 $183,757 ($1,000,000) $220,370 $204,047 $188,932 $174,937 $161,979 ($1,000,000) $279,630 $258,916 $239,737 $221,979 $205,536
NPV $78,032 ($49,735) $205,798

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Transcribed Image Text

Suppose that a company is considering an investment in a newproduct with a 5-year horizon (product will be sold for 5 years).The upfront investment is $1 million and it is assumed todepreciate on a straight-line basis for 5 years, with no residualvalue. Fixed costs are assumed to be $50,000 per year. The companyestimates the variable cost per unit (v) to be $5 and expects tosell each unit for $15. There are no taxes and the required rate ofreturn is 8% per year.The company estimates that they will be able to sell 32,000 unitsduring the year under normal circumstances (base case), but theybelieve that actual sales could be 10% lower than 32,000 (worstcase) or 10% higher than 32,000 (best case).Base Case NPV =Worst Case NPV =  Best Case NPV =

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