Question 345 capital budgeting, break even, NPV
|Project life||10 yrs|
|Initial investment in factory||$10m|
|Depreciation of factory per year||$1m|
|Expected scrap value of factory at end of project||$0|
|Sale price per unit||$10|
|Variable cost per unit||$6|
|Fixed costs per year, paid at the end of each year||$2m|
|Interest expense per year||0|
|Cost of capital per annum||10%|
- The firm's current liabilities are forecast to stay at $0.5m. The firm's current assets (mostly inventory) is currently $1m, but is forecast to grow by $0.1m at the end of each year due to the project.
At the end of the project, the current assets accumulated due to the project can be sold for the same price that they were bought.
- A marketing survey was used to forecast sales. It cost $1.4m which was just paid. The cost has been capitalised by the accountants and is tax-deductible over the life of the project, regardless of whether the project goes ahead or not. This amortisation expense is not included in the depreciation expense listed in the table above.
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
Find the break even unit production (Q) per year to achieve a zero Net Income (NI) and Net Present Value (NPV), respectively. The answers below are listed in the same order.