ch11solution_prob - Answers to Concepts Review and Critical...

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Answers to Concepts Review and Critical Thinking Questions 2. With a sensitivity analysis, one variable is examined over a broad range of values. With a scenario analysis, all variables are examined for a limited range of values. Solutions to Questions and Problems 3. The base-case, best-case, and worst-case values are shown below. Remember that in the best-case, sales and price increase, while costs decrease. In the worst-case, sales and price decrease, and costs increase. Unit Scenario Unit Sales Unit Price Variable Cost Fixed Costs Base 105,000 KRW 1,800 M KRW 1,700 M KRW 6,000 M Best 120,750 KRW 2,070 M KRW 1,445 M KRW 5,100 M Worst 89,250 KRW 1,530 M KRW 1,955 M KRW 6,900 M 4. An estimate for the impact of changes in price on the profitability of the project can be found from the sensitivity of NPV with respect to price: NPV/ P. This measure can be calculated by finding the NPV at any two different price levels and forming the ratio of the changes in these parameters. Whenever a sensitivity analysis is performed, all other variables are held constant at their base-case values. 5. b. We will use the tax shield approach to calculate the OCF. The OCF is: OCF base = [(P – v)Q – FC](1 – t c ) + t c D OCF base = [($40 – 25)(100,000) – $900,000](0.65) + 0.35($112,000) OCF base = $429,200
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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 = –$896,000 + $429,200(PVIFA 15%,8 ) NPV base = $1,029,958.39 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 105,000 units. The NPV at this sales level is: OCF new = [($40 – 25)(105,000) – $900,000](0.65) + 0.35($112,000) OCF new = $477,950 And the NPV is: NPV new = –$896,000 + $477,950(PVIFA 15%,8 ) NPV new = $1,248,715.31 So, the change in NPV for every unit change in sales is: NPV/ S = ($1,248,715.31– 1,029,958.39)/(105,000 – 100,000) NPV/ S = +$43.751 If sales were to drop by 500 units, then NPV would drop by: NPV drop = $43.751(500) = $21,875.69 You may wonder why we chose 105,000 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. c. To find out how sensitive OCF is to a change in variable costs, we will compute the OCF at a variable cost of $24. Again, the number we choose to use here is irrelevant: We will get the same ratio of OCF to a one dollar change in variable cost no matter what variable cost we use. So, using the tax shield approach, the OCF at a variable cost of $24 is: OCF new = [($40 – 24)(100,000) – 900,000](0.65) + 0.35($112,000) OCF new = $494,200 So, the change in OCF for a $1 change in variable costs is: OCF/ v = ($429,200 – 494,200)/($25 – 24) OCF/ v = –$65,000 If variable costs decrease by $1 then, OCF would increase by $65,000 6. We will use the tax shield approach to calculate the OCF for the best- and worst-case scenarios. For
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This note was uploaded on 09/18/2010 for the course BUSS 207 taught by Professor Jinwanchoi during the Spring '10 term at Korea University.

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ch11solution_prob - Answers to Concepts Review and Critical...

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