PROJECT EVALUATION AND SENSITIVITY ANALYSIS
Assume that your group is working for financial department of a company, which is considering a potential project with a new product that is expected to sell for an average price of $25 per unit. Launching this project will require the company to choose either one of the following equipment:
– Equipment A with the cost of $1 500 000 and zero residual value after four years. The company expects it can sell 250 000 unit per year at this price for a period of 4 years with this equipment
– Equipment B with the cost of $2 000 000 and zero residual value after four year. The company expects it can sell 270 000 unit per year at this price for a period of 4 years with this equipment
For both equipment, to produce a unit of product, the company needs to spend a variable cost per unit of $10. Cash fixed costs per year is $250 000. Other information is available below:
Depreciation Method: straight line
Discount rate: 12%
Tax Rate: 30%
a. Computing annual operating cashflow (OCF) for the investment project with each equipment by tax shield approach.
b. Assume that company chooses the Equipment A, do an analysis with cash flows of the project to determine the sensitivity of the project NPV with the following changes in the value drivers and provide your results in relevant tables:
Unit sales decrease by 10%
Price per unit decreases by 10%
A conclusion on which value driver have greater impact on the NPV of the project cash flows need to be drawn out.
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