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1) The most likely outcomes for a particular project are estimated as follows. Unit price will be $60, variable cost per unit will be $40, fixed costs will be $400,000 and expected sales will be 35,000 units per year. However, you recognize that some of these estimates are subject to error. Suppose that each variable may turn out to be either 5% higher or 5% lower than the initial estimate. The project will last for 20 years and requires an initial investment of $1.4 million, which will be depreciated straight-line over the project life to a final value of zero. The firm's tax rate is 35% and the required rate of return is 15%. What is project NPV in the "best-case scenario", that is assuming all variables take on the best possible value? What about the worst-case scenario?
2) Modern Artifacts can produce keepsakes that will be sold for $100 each. Non-depreciation fixed costs are $900 per year and variable costs per unit are $80. If the project requires an initial investment of $4,900 and is expected to last for 7 years and the firm pays no taxes, what are the accounting and NPV break-even levels of sales in terms of number of units sold? The initial investment will be depreciated straight-line over 7 years to a final value of zero, and the discount rate is 10%.
3) What is the degree of operating leverage for Modern Artifacts in the previous problem when sales are $12,000? What is the degree of operating leverage when sales are $18,000? Why is operating leverage different at these two levels of sales?
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