Break-even and Sensitivity Analysis
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The Clayton Manufacturing Company is considering an investment in a new automated inventory system for its warehouse that will provide cash savings to the firm over the next five years. The firm's CFO anticipates additional earnings before interest, taxes, depreciation, and amortization (EBITDA) from cost savings equal to $200,000 for the first year of operation of the center, and over the next year the firm estimates this amount will grow at a rate of 5% per year. The system will require an initial investment of $800,000 that will be depreciated over a five year period using straight-line depreciation of $160,000 per year and a zero estimated salvage value.
a. Calculate the project's annual project free cash flow (PFCF)for each of the next five years where the firm's tax rate is 35%.
b. If the cost of capital for the project is 12%, what is the projected NPV for the investment?
c. What is the minimum Year 1 dollar saving (i.e. EBITDA) required to produce a breakeven NPV=0
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Solution Summary
This solution illustrates how to perform a break-even analysis and a sensitivity analysis.
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