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# Capital Budgeting, Break-even

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9-6A. (Net present value, profitability index, and internal rate of return calculations) You are considering two independent projects, project A and project B. The initial cash outlay associated with project A is \$50,000 and the initial cash outlay associated with project B is \$70,000. The required rate of return on both projects is 12 percent. The expected annual free cash flows from each project are as follows:
YEAR PROJECT A PROJECT B
0 &#8722;\$50,000 &#8722;\$70,000
1 12,000 13,000
2 12,000 13,000
3 12,000 13,000
4 12,000 13,000
5 12,000 13,000
6 12,000 13,000
Calculate the NPV, PI, and IRR for each project and indicate if the project should be accepted.

15-2A. (Break-even point) Napa Valley Winery (NVW) is a boutique winery that produces a high-quality, nonalcoholic red wine from organically grown cabernet sauvignon grapes. It sells each bottle for \$30. NVW's chief financial officer, Jackie Cheng, has estimated variable costs to be 70 percent of sales. If NVW's fixed costs are \$360,000, how many bottles of its wine must NVW sell to break even?

15-10A. (Break-even point and profit margin) Mary Clark, a recent graduate of Clarion South University, is planning to open a new wholesaling operation. Her target operating profit margin is 26 percent. Her unit contribution margin will be 50 percent of sales. Average annual sales are forecast to be \$3,250,000.
a. How large can fixed costs be for the wholesaling operation and still allow the 26 percent operating profit margin to be achieved?
b. What is the break-even point in dollars for the firm?

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#### Solution Preview

9-6A. (Net present value, profitability index, and internal rate of return calculations) You are considering two independent projects, project A and project B. The initial cash outlay associated with project A is \$50,000 and the initial cash outlay associated with project B is \$70,000. The required rate of return on both projects is 12 percent. The expected annual free cash flows from each project are as follows:
YEAR PROJECT A PROJECT B
0 &#8722;\$50,000 &#8722;\$70,000
1 12,000 13,000
2 12,000 13,000
3 12,000 13,000
4 12,000 13,000
5 12,000 13,000
6 12,000 13,000
Calculate the NPV, PI, and IRR for each project and indicate if the project should be accepted.

Since the cash flows are the same over the years (annuity) we can use PVIFA factor to calculate NPV
PVIFA= Present Value Interest Factor for an Annuity
It can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%

Project A

1) NPV
Initial investment= \$50,000
Annual cash flow= \$12,000

We first calculate the Present value of annuity to be received each year years and then subtract the initial outlay to calculate NPV
n= 6
r= 12.00%
PVIFA (6 periods, 12.% rate ) = 4.111407

Annuity= 12,000
Therefore, present value= 49,337 =12000x4.111407

Initial investment= \$50,000
Therefore NPV= (\$663) =49337-50000

2) ...

#### Solution Summary

Provides answers to 3 questions
1) Net present value, profitability index, and internal rate of return calculations
2) Break-even point
3) Break-even point and profit margin

\$2.49