Question

You are considering a new product launch. The project will cost $2,125,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 240 units per year; price per unit will be $18,900, variable cost per unit will be $12,650, and fixed costs will be $630,000 per year. The required return on the project is 9 percent, and the relevant tax rate is 22 percent. a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±10 percent. What are the upper and lower bounds for these projections? What is the base-case NPV? What are the best-case and worst-case scenarios? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your NPV answers to 2 decimal places, e.g., 32.16. Round your other answers to the nearest whole number, e.g. 32.)

Answer 1

The question involves calculating the NPV for a new product launch with variable estimates for sales, costs, and projections. Upper and lower bounds for the estimates are determined, and the NPV for base-case, best-case, and worst-case scenarios is calculated using a required return of 9% and a tax rate of 22%.

Step-by-step explanation:

The student is considering the launch of a new product and must evaluate the net present value (NPV) of the project with varying sales, costs, and projections. The base-case scenario involves calculating the projected cash flows based on given sales of 240 units per year at a price of $18,900 per unit, variable costs of $12,650 per unit, and fixed costs of $630,000 per year. Given that the project has no salvage value and will be depreciated straight-line to zero over its four-year life, the depreciation expense will be $531,250 per year ($2,125,000 total project cost / 4 years). Applying the required return of 9% and a tax rate of 22%, we can calculate the NPV of the project.

Considering that the estimates could be off by ±10%, we calculate the upper and lower bounds for sales, variable costs, and fixed costs. For sales, the upper bound is 264 units (240 × 1.1) and the lower bound is 216 units (240 × 0.9). For variable costs, the upper bound is $13,915 per unit ($12,650 × 1.1) and the lower bound is $11,385 per unit ($12,650 × 0.9). For fixed costs, the upper bound is $693,000 ($630,000 × 1.1) and the lower bound is $567,000 ($630,000 × 0.9).

To evaluate the best-case and worst-case scenarios, we modify the sales, variable costs, and fixed costs according to the upper and lower bounds. The best-case scenario assumes the highest sales, lowest variable costs, and lowest fixed costs, while the worst-case scenario assumes the lowest sales, highest variable costs, and highest fixed costs. Using these projections, we can calculate the best-case and worst-case NPV.