Scribd
Upload
39 views2 pages

Topic 2 - Problem Set

Questions related to NPV and break even

Uploaded by

rebecca
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
39 views2 pages

Topic 2 - Problem Set

Questions related to NPV and break even

Uploaded by

rebecca
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

1.

The Rustic Welt Company is proposing to replace its old welt-making machinery with
more modern equipment. The new equipment costs $9 million (the existing equipment has
zero salvage value). The attraction of the new machinery is that it is expected to cut
manufacturing costs from their current level of $8 a welt to $4. However, as the following
table shows, there is some uncertainty both about future sales and about the performance
of the new machinery.

Pessimistic Expected Optimistic


Sales (millions of welts) 0.4 0.5 0.7
Manufacturing cost with new machinery (dollars per welt) 6 4 3
Economic life of new machinery (years) 7 10 13

Conduct a sensitivity analysis of the replacement decision, assuming a discount rate of 12%
and enter the Equivalent Annual Cost Savings in the table below. Rustic Welt does not pay
taxes.

2. Dog Days is considering a proposal to produce and market a caviar-flavored dog food. It
will involve an initial investment of $90,000 that can be depreciated for tax straight-line
over 10 years. In each of years 1 to 10, the project is forecast to produce sales of $100,000
and to incur variable costs of 50% of sales and fixed costs of $30,000. The corporate tax rate
is 30%, and the cost of capital is 10%
a. Calculate the NPV and accounting break-even levels of fixed costs
b. Suppose that you are worried that the corporate tax rate will be increased immediately after
you commit to the project. Calculate the break-even rate of taxes.
c. How would a rise in the tax rate affect the accounting break-even point?

3. Modern Artifacts can produce keepsakes that will be sold for $110 each. Nondepreciation
fixed costs are $1,600 per year, and variable costs are $90 per unit. The initial investment of
$4,500 will be depreciated straight-line over its useful life of five years to a final value of
zero, and the discount rate is 10%.
a. What is the accounting break-even level of sales if the firm pays no taxes?
b. What is the NPV break-even level of sales if the firm pays no taxes?
c. What is the accounting break-even level of sales if the firm’s tax rate is 20%?
d. What is the NPV break-even level of sales if the firm’s tax rate is 20%?

4. Modern Artifacts can produce keepsakes that will be sold for $91 each. Nondepreciation
fixed costs are $1,000 per year, and variable costs are $68 per unit. The initial investment of
$4,100 will be depreciated straight-line over its useful life of five years to a final value of
zero, and the discount rate is 12%.
a. What is the degree of operating leverage of Modern Artifacts when sales are $7,735?
b. What is the degree of operating leverage when sales are $13,195?
5. In a slow year, Deutsche Burgers will produce 2 million hamburgers at a total cost of $3.5
million. In a good year, it can produce 4 million hamburgers at a total cost of $4.5 million.
a. What are the fixed costs of hamburger production?
b. What are the variable costs when the firm produces 2 million hamburgers?
c. What is the average cost per burger when the firm produces 1 million hamburgers?
d. What is the average cost when the firm produces 2 million hamburgers?

6. An auto plant that costs $100 million to build can produce hybrid cars. If successful, the
investment will produce cash flows with present value of $140 million. If unsuccessful, the
cash flows are only $50 million, in present value terms. The probability of success is 50%.
You only find out whether the plant is a success or failure after it is built.
a. Would you build the plant?
b. Suppose you could immediately sell the plant to another automaker for $95
million, if your line is unsuccessful. Does your decision change?
c. Illustrate the option to abandon in part (b) using a decision tree

You might also like