# IP-2 - PROBLEM 3-2 Breakeven Sensitivity Analysis Given...

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Given Investment (enter with "-" sign) \$(4,000,000) Plant life 5 Years Salvage value \$400,000 Variable Cost % 45% Fixed operating cost \$1,000,000 Tax rate 38% Working capital 10% Required Rate of Return 15% Sales volume multiple 1.00 Yea 0 1 2 Sales volume \$1,000,000 \$1,500,000 Unit price 2.00 2.00 Revenues 2,000,000 3,000,000 Variable Operating Costs (900,000) (1,350,000) Fixed Operating Costs (1,000,000) (1,000,000) Depreciation Expense (800,000) (800,000) Net Operating Income \$(700,000) \$(150,000) Less: Taxes 266,000 57,000 NOPAT \$(434,000) \$(93,000) Plus: Depreciation 800,000 800,000 Less: CAPEX (4,000,000) - - Less: Working Capital (200,000) (100,000) (450,000) Free Cash Flow \$(4,200,000) \$266,000 \$257,000 NPV \$419,435 IRR 18% Equivalent Annual Cost \$125,124.06 Solution a. What are the key sources of risk that you see in this project? b. Breakeven sensitivity analysis Variable Initial Capex \$(4,419,435) Variable Cost as a % of Sales 49% Use Goal Seek to find these nu Working Capital % of new Sales 27% Sales volume multiplier 0.92 PROBLEM 3-2: Breakeven Sensitivity Ana (Percent of the expected The "given" data or parameters capture the variables that are uncertain in the analysis. However, the sensitivity analysis is designed to identify the key sources of uncertainty that are most crucial. Breakeven Value

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c. Discuss results of part b. d. Should you always seek to reduce project risk? The initial capital cost, variable cost as a percent of sales and the sales volume are all roughly equally important in terms of their significance in driving the results of the investment. The kinds of things that can be done to control these costs entail careful cost contracting for the initial capital cost, and closely monitoring both the variable cost % and sales volume. It would also be helpful to know what "options" the firm might have with regard to reducing output or shutting down should the forecasts of sales volume or variable costs prove to be optimistic. This should provide an interesting discussion since most students are taught that risk is bad.
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## This note was uploaded on 07/24/2009 for the course FIN FIN taught by Professor Robbani during the Summer '09 term at University of Maryland Baltimore.

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IP-2 - PROBLEM 3-2 Breakeven Sensitivity Analysis Given...

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