fin-ch11-hw-practice - 1 Olin Transmissions Inc has the...

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1. Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price = $1,900 per unit; variable costs = $380 per unit; fixed costs = $4.1 million; quantity = 84,000 units. Suppose the company believes all of its estimates are accurate only to within ±15 percent. What values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario? Scenario Units Sales Unit Price Unit Variable cost Fixed Costs Base 84,000 $ 1,900 $ 380 $ 4,100,000 Best 96,600 ± 0.1% 2,185 ± 0.1% 323 ± 1% 3,485,000 ± 0.01% Worst 71,400 ± 0.1% 1,615 ± 0.1% 437 ± 1% 4,715,000 ± 0.01% Explanation: Remember that in the best-case, sales and price increase, while costs decrease. In the worst-case, sales and price decrease, and costs increase.
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2. We are evaluating a project that costs $732,000, has a six-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 55,000 units per year. Price per unit is $60, variable cost per unit is $30, and fixed costs are $640,000 per year. The tax rate is 35 percent, and we require a 12 percent return on this project. a-1 Calculate the accounting break-even point. Break-even point 25,400 ± 0.1% units a-2 What is the degree of operating leverage at the accountin g break-even point? (Round your answer to 3 decimal places. (e.g., 32.161)) DOL 6.246 ± 1% b-1 Calculate the base-case cash flow and NPV. (Round your NPV answer to 2 decimal places. (e.g., 32.16)) Cash flow $ 699,200 ± 0.1% NPV $ 2,142,696.00 ± 0.1% b-2 What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your answer to 3 decimal places. (e.g., 32.161)) ΔNPV/ΔQ $ 80.172 ± 1% c. What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign.) ΔOCF/ΔVC $ -35,750 ± 0.1% Explanation: a. To calculate the accounting breakeven OCF, we first need to find the depreciation for each year. The depreciation is: Depreciation = $732,000/6 Depreciation = $122,000 per year And the accounting breakeven is: Q A = ($640,000 + 122,000)/($60 – 30) Q A = 25,400 units To calculate the accounting breakeven, we must realize at this point (and only this point), the OCF is equal to depreciation. So, the DOL at the accounting breakeven is: DOL = 1 + FC/OCF = 1 + FC/D DOL = 1 + [$640,000)/$122,000)] DOL = 6.246 b. We will use the tax shield approach to calculate the OCF. The OCF is: OCF base = [(P – v)Q – FC](1 – T ) + T D OCF base = [($60 – 30)(55,000) – $640,000](0.65) + 0.35($122,000) OCF base = $699,200
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Now we can calculate the NPV using our base-case projections. There is no salvage value or NWC, so the NPV is: NPV base = –$732,000 + $699,200(PVIFA 12%,6 ) NPV base = $2,142,696.00 To calculate the sensitivity of the NPV to changes in the quantity sold, we will calculate the NPV at a different quantity. We will use sales of 60,000 units. The NPV at this sales level is: OCF new = [($60 – 30)(60,000) – $640,000](0.65) + 0.35($122,000) OCF new = $796,700 And the NPV is: NPV new = –$732,000 + $796,700(PVIFA 12%,6 ) NPV new = $2,543,558.21 So, the change in NPV for every unit change in sales is: ΔNPV/ΔS = ($2,142,696.00 – 2,543,558.21)/(55,000 – 60,000) ΔNPV/ΔS = +$80.172 If sales were to drop by 500 units, then NPV would drop by: NPV drop = $80.172(500) = $40,086.22 You may wonder why we chose 60,000 units. Because it doesn’t matter! Whatever sales number we use, when we calculate the change in NPV per unit sold, the ratio will be the same.
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  • Spring '08
  • Titus-Piersma
  • Finance, OCF

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