Corporate Finance

Workshop 3
Dr Xiaohu Deng
Due at 12:00pm (Noon) on Monday, 15 March 2019

Submission Instructions:
Your weekly tutorial solutions must be typed in one document in Word or PDF formats (Scan copy of handwritten work is not accepted). You must submit your
weekly tutorial solutions through the 'Tutorial Task Submissions' link under the 'Assessment' folder: Dropbox on the MyLO site. This assignment will
not be accepted after 12.00pm on Monday, 16 March. Please ensure you include your name and student ID number in your submission.
If you have problems uploading your assignment onto the dropbox, you MUST contact your lecturer immediately explaining the situation by email
AND attach your weekly tutorial solutions in the email before the due time. The standard rules of attribution of authorship of ideas apply. And note
that plagiarism must be avoided.

Question 1
A project under consideration costs $1500 000, has a five year life and has no salvage value. Depreciation is straight-line to zero. The required return
is 15 percent and tax rate is 30 per cent. Sales are projected at 1000 units per year. Price per unit is $6 000, variable cost per unit is $3800 and fixed
costs are $500 000 per year. Assume no increase in working capital and no additional capital outlays. What are the cash, accounting and financial
break-even sales levels for this project? Ignore taxes in answering.

Question 2
Odion Manufacturer’s Ltd is evaluating a project that costs $280000, has a seven-year life, and no salvage value. Assume that depreciation is prime-
cost to zero salvage over the 7-years. Odion requires a return of 10 per cent on such projects. The tax rate is 30 per cent. Sales are projected at 60000
units per year. Price per unit is $23.80, variable cost per unit is $10.52 and fixed costs are $100000 per year.
a. Calculate the accounting break-even point. What is the degree of operating leverage at the accounting breakeven point?

b. Calculate the base-case cash flow and NPV. Suppose that you think that the sales projection is accurate only to within 25 per cent. Evaluate the
sensitivity of NPV to changes in that projection.

c. Suppose the projections given are all accurate to within 5 per cent except for sales volume, which is only accurate to within 15 per cent. Calculate
the NPV under the best and worst cases.

Question 3
We are examining a new project. We expect to sell 500 units per year at $18 net cash flow each year for the next 10 years. In other words, the annual
operating cash flow is projected to be $18 × 500 = $9 000 per year. The relevant discount rate is 18 per cent, and the initial investment is $50 000.
Ignore taxation.
a) What is the base case NPV?

b) After the first year, the project can be dismantled and sold for $36 000. If expected sales are revised based on the first year’s performance, when
would it make sense to abandon the investment? In other words, at what level of expected sales would it make sense to abandon the project?