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CHAPTER 10 B-197 c . To find the highest level of fixed costs and still breakeven, we need to use the tax shield approach to calculating OCF, and solve the problem similar to finding a bid price. Using the initial cash flow and salvage value we already calculated, the equation for a zero NPV of the project is: NPV = 0 = –\$940,000 – 75,000 + OCF(PVIFA 12%,5 ) + [(\$75,000 + 45,500) / 1.12 5 ] OCF = \$946,625.06 / PVIFA 12%,5 = \$262,603.01 Notice this is the same OCF we calculated in part b . Now we can use the tax shield approach to solve for the maximum level of fixed costs as follows: OCF = \$262,603.01 = [(P–v)Q – FC ](1 – t C ) + t C D \$262,603.01 = [(\$13.00 – 9.25)(185,000) – FC](1 – 0.35) + 0.35(\$940,000/5) FC = \$390,976.15 As a check, we can calculate the NPV of the project with this level of fixed costs. The calculations are: Year 1 2 3 4 5 Sales \$2,405,000 \$2,405,000 \$2,405,000 \$2,405,000 \$2,405,000 Variable costs 1,711,250 1,711,250 1,711,250 1,711,250 1,711,250 Fixed costs 390,976 390,976 390,976 390,976 390,976 Depreciation 188,000 188,000 188,000 188,000 188,000 EBIT 114,774 114,774 114,774 114,774 114,774 Taxes (35%) 40,171 40,171 40,171 40,171 40,171 Net Income 74,603 74,603 74,603 74,603 74,603 Depreciation 188,000 188,000 188,000 188,000 188,000 Operating CF \$262,603 \$262,603 \$262,603 \$262,603 \$262,603 Year 1 2 3 4 5 Operating CF \$262,603 \$262,603 \$262,603 \$262,603 \$262,603 Change in NWC 0 00 0 75,000 Capital spending 0 0 45,500 Total CF \$262,603 \$262,603 \$262,603 \$262,603 \$383,103 NPV = –\$940,000 – 75,000 + \$262,603(PVIFA 12%,5 ) + [(\$75,000 + 45,500) / 1.12 5 ] \$0 35. We need to find the bid price for a project, but the project has extra cash flows. Since we don’t already produce the keyboard, the sales of the keyboard outside the contract are relevant cash flows. Since we know the extra sales number and price, we can calculate the cash flows generated by these sales. The cash flow generated from the sale of the keyboard outside the contract is: 1 2 3 4 Sales \$855,000 \$1,710,000 \$2,280,000 \$1,425,000 Variable costs 525,000 1,050,000 1,400,000 875,000 EBT \$330,000 \$660,000 \$880,000 \$550,000 Tax 132,000 264,000 352,000 220,000 Net income (and OCF) \$198,000 \$396,000 \$528,000 \$330,000

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B-198
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