(Sensitivity Analysis and Break-Even Point): We are evaluating a project that costs $588,000; has an eight-year life and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 70,000 units per year. Price per unit is $36, variable cost per unit is $20, and fixed costs are $695,000 per year. The tax rate is 35 percent, and we require a return of 15 percent on this project.
Part a: Calculate the accounting break even.
Part b: Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500-unit decrease in projected sales? (Professor Cursio comments: some textbooks use the term “sensitivity” to literally mean add one and/or subtract one unit of something – in this case sales – to see what the changes are. But for our purposes, the only sensitivity we care about is what the effect would be if sales are 500 units less than the base-case projection.)
Part c: What is the sensitivity of OFC to changes in the variable cost figure? Explain what your answer tells you about a $1 decrease in variables costs. (Professor Cursio comments: similar to part b, all we care about is the effect of variable costs being one dollar less than the base-case projection.)