Calculate the accounting break-even point

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Reference no: EM133491951

Question 1

Case: We are evaluating a project that costs $910,000, has a seven -year life, and a salvage value of $125,000. Assume a straight-line depreciation over the life of the project. Sales are projected at 53,000 units per year, price per unit is $69, variable costs per unit is $41, and annual fixed operating costs are estimated to be$705,000 a year. The tax rate is 23% and we require a return of 12% on this project.

Required

(a) Calculate the accounting break-even point.

(b) Calculate the financial break-even point.

(d) What would the NPV be if projected annual sales increased by 1,000 units?

(e) Go back to the original information. What would the NPV be if estimated variable costs decreased by $5?

(e) Suppose the projections given in price, quantity, sales figure, and fixed and variable costs, are all accurate within ± 10%. Calculate the best-case and worst-case NPV figures.

Question 2

Mickelson Golf has decided to sell a new line of golf clubs, called Mickelson ClassicTM. The clubs will sell for $835 per set and have a variable cost of $375 per set. The company has spent $130,000 to conduct a market survey that determined the company will sell 55,000 sets per year for seven years. The market survey also found that the company would potentially lose sales of 11,000 sets of its high-priced clubs, called Mickelson PremiumTM as a result of introducing this new line of clubs.

The premium clubs sell at $1,375 and have variable costs of $735 per set. On the brighter side, as a result of the introduction of the new clubs, the company will increase sales of its everyday, cheaper, clubs, called Mickelson HeritageTM by 10,000 sets. The cheap clubs sell at $395 and have variable costs of $200 per set.

Annual fixed costs are estimated to be $8.45 million. The company has also spent $1 million on research and development of the new clubs. The plant and equipment required to manufacture the new clubs will cost $40.5 million and will be depreciated on a straight-line basis to an estimated salvage value of $2 million at the end of the project's life. Production of the new clubs will also require an increase in net working capital of $3 million at inception and a further $2.0 million at the end of the 3rd year. Fifty-percent of all working capital will be returned at the end of the project. The company's tax rate is 21%, and its cost of capital is 11%.

Required

(a) Calculate the payback period, the NPV, and the IRR.

(b) You feel the values described above are accurate to within only ± 10 percent. What are the best-case and worst-case NPVs? (Hint: The selling price and variable costs for the two existing sets of clubs, i.e., the high-priced and cheap clubs are known with certainty; only the sales gained or lost are uncertain, i.e., may fluctuate within ± 10 percent.)

(c) Go back to the original information. Mickelson Golf would like to know the sensitivity of NPV to changes in the price of the new clubs and quantity of the new clubs sold. What is the sensitivity of the NPV to each of these variables? (Hint: Answer to this question would involve 3 parts: first, calculate the change in NPV for a $1 increase or decrease in the price of new clubs; second, calculate the change in NPV for a 1-unit increase or decrease in the number of club sets sold; and third, calculate the change in NPV for the combined effect of a $1 increase in club price and a 1-unit increase in the number of sets sold.)

(d) Go back to the original information. The company bought some land 3 years ago for $1.9 million in anticipation of using it as its new factory site. Based on a recent appraisal, the company believes it could sell the land for $2.2 million on an after-tax basis. In seven years, the land could be sold for $2.4 million after-taxes. What effect will this information have on the NPV calculated in (a) above?

(e) Finally, return to original information and assume that both the number of sets sold and price per set increase by 5% and variable costs increase by 3% annually, what would be the new NPV?

Reference no: EM133491951

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