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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 basecase, bestcase, and worstcase values are shown below. Remember that in the bestcase,
sales and price increase, while costs decrease. In the worstcase, 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 basecase
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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View Full DocumentNow we can calculate the NPV using our basecase 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 worstcase scenarios. For
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 Spring '10
 JinWanChoi

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