C-11

IRR - as high as possible
However, we have to look

at:
Projected vs. actual cash flows
Discounted CF
Forecasting risks
Source of value

of what happens to NPV estimates when we ask what

if questions.
Pessimistic, most likely, optimistic
Sensitivity analysis is investigation of what happens to NPV when one variable is changed
Simulation analysis is a combination of scenario and sensitivity analysis

inexpensive golf clubs for teenagers. The company expects to sell

these clubs for $100 a set, plus or minus 2%. The sales manager estimates that 20,000 sets can be sold, plus or minus 5%.
What is the expected amount of sales under the worst case scenario?

unit but changes in total in proportion to changes in

the cost driver
materials (parts), fuel costs for a trucking company

$

Volume

$

Volume

Fixed Cost
a cost which does not change in total as volume changes but changes on a per-unit basis as the cost driver increases and decreases
amortization, insurance

steering wheels for hot rods. The projected fixed costs of

this project are $18,000. Variable costs are estimated at $54.90 per wheel. The cost estimates are considered accurate within a plus or minus range of 5%. The depreciation expense is $8,000 per year. Bob’s expects to sell 1,500 wheels, plus or minus 3%. The sales price is estimated at $139.00, plus or minus 5%.
What is the projected earnings before interest and taxes under the best case scenario?

Sales= 1,500  (1 + .03)  $139.00  (1 + .05) = $225,493
Var.cost= 1,500  (1 + .03)  $54.90  (1 - .05) = $ 80,579
Fixed cost = $18,000  (1 - .05) = $ 17,100
Depreciation = $8,000 = $ 8,000
EBIT = $119,814

a result will change if the original predicted data are

not achieved or if an underlying assumption changes
What will happen to operating income if volume declines by 5%?
What will happen to operating income if variable costs increase by 10% per unit?
Sensitivity analysis broadens management’s perspectives about possible outcomes

at sporting events. The company has developed the following estimates:
Sales

25,000 units  10%
Variable cost $.59 per unit  5%
Fixed cost $7,500  2%
Selling price $1.25 per unit  5%
Depreciation $1,000
What is the earnings before interest and taxes for a sensitivity analysis using a variable cost of $.60 per unit?

Sales = 25,000  $1.25 = $31,250
Variable cost = 25,000  $.60 = $15,000
Fixed cost = $7,500 = $ 7,500
Depreciation = $1,000 = $ 1,000
EBIT = $ 7,750

selling homemade cookies on the waterfront during tourist season. The

company has developed these estimates:

Sales 6,000 cookies  20%
Var.costs $.69 per cookie  4%
Fixed costs $500  3%
Sales price $1.10  5%
Depreciation $800
Tax rate 34%

What is the operating cash flow for a sensitivity analysis using a sales quantity of 6,500 cookies?

$4,485
Fixed cost = $500 = $ 500
Depreciation = $800 = $ 800
EBIT =

$1,365
Tax = .34  $1,365 = $ 464
Net income = $ 901

OCF = EBIT + Depreciation – Taxes = $1,365 + $800 - $464 = $1,701
OCF = [(Sales – Costs)  (1 – Tax rate)] + [Depreciation  tax rate] = {[6,500  ($1.10 - $.69)] - $500} {1 - .34} + {$800  .34} = $1,428.90 + $272.00 = $1,700.90
= $1,701 (rounded to whole dollars)

company pays $1,200 a month for rent. Other fixed costs

are $500 monthly.
The variable cost per sandwich is $2.89. Assume a month has 30 days.
What are the monthly total costs incurred by Sandwiches To Go?

Total monthly cost = (500  30  $2.89) + $1,200 + $500 = $43,350 + $1,700 = $45,050

of fresh cut flowers each year. Total labor cost for

the year are $68,000. Total material costs for the year are $28,470. Daisy’s computed that at the current level of production the labor cost per additional unit is $1.40 and the material costs are $2.09.
Fixed costs for the year are $50,000. Annual depreciation is $55,000 on the greenhouses and equipment. Ignore taxes.
What is the average total cost per bouquet?
What is the minimum price Daisy’s should charge if they can obtain a one-time special order for an additional 250 bouquets?

revenue and total variable costs
Contribution margin per unit
= Selling price -

Variable cost per unit
Contribution margin percentage
= Contribution margin per unit / selling price per unit

Total for
Per Unit 2 units %
Revenue $200 $400 100%
Variable costs 120 240 60%
Contribution margin $80 $160 40%

aged 3 to 6. Jack’s sells these cars for $320

each. The company has fixed monthly expenses of $1,500. The variable cost per car is $212. During an average month, Jack’s sells 20 of these toy cars.
What is the contribution margin per car sold?

point where operating income equals zero
Breakeven point in units
= Fixed costs

/ Contribution margin per unit
= $2,000 / $80 = 25 units

Breakeven point in dollars
= Fixed costs /Contribution margin %
= $2,000 / 40% = $5,000

and quantity of output or sales volume (Q)
Q= (FC+ OCF)/(P-v)

where FC- Fixed costs
P- price per unit
V- variable cost per unit
Accounting BE – the sales level results in zero project net income
Q= (FC+D) /(P-v)
where D – depreciation
Cash BE – the sales level that results in a zero OCF
Q = FC/ (P-v)

a zero NPV
Q= (FC+ OCF*) /(P-v)
where

OCF* is the level of OCF that results zero NPV

a sales price of $11.99, fixed costs of $7,500, depreciation

of $2,400 and variable costs per unit of $6.20. Ignore taxes.
What is the accounting break-even level of production?

costs of $2,100, depreciation expense of $900 and a sales

quantity of 2,500 units. Ignore taxes.
What is the contribution margin per unit if the projected level of sales is at the accounting break-even point?

outlet. Fixed costs are estimated at $160,000 per year. The

forecasted sales price is $1.59 per pretzel. Variable costs per pretzel are $.79.
What is the cash break-even point for this new retail outlet?

costs of $12,500, depreciation expense of $5,400 and a contribution

margin of $2.05.
Willsen wants to know how many units of this product will have to be sold so that his potential loss is limited to his initial investment. What should you tell him?

an operating cash flow of $22,600 when the net present

value is equal to zero. At that level of sales, the selling price per unit is $14.95, the variable cost per unit is $8.60 and the fixed costs are $19,000.
What is the financial break-even sales quantity?

or project relies on fixed costs
Degree of Operating leverage is

the percentage in operating CF relative to the percentage change in quantity sold
% change in OCF = DOL x % change in Q
DOL = 1+FC/OCF

to % change in quantity sold.
A project has fixed costs

of $2,500 and variable costs per unit of $10.15. The depreciation expense is $1,100. The operating cash flow is $6,400.
What is the degree of operating leverage?

of operating leverage. Sales are expected to increase by 4%

next year.
What is the expected percentage change in operating cash flow for next year?

firm has a positive NPV projects but cannot find the

necessary financing
Soft- the situation when units in a business are allocated a certain amount of financing fro capital budgeting
Hard – when a business cannot raise financing for a project under any circumstances