Emperor's Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 6 million jars of makeup a year. Fixed costs are $2 million a year, and variable costs are $1 per jar. The product will be priced at $2 per jar. The plant will be depreciated straight-line over 5 years to a salvage value of zero. The opportunity cost of capital is 10 percent, and the tax rate is 40 percent.

a. What is project NPV under these base-case assumptions?
b. What is NPV if variable costs turn out to be $1.20 per jar?
c. What is NPV if fixed costs turn out to be $1.5 million per year?
d. At what price per jar would project NPV equal zero?

Solution Preview

Sensitivity Analysis. Emperor's Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 6 million jars of makeup a year. Fixed costs are $2 million a year, and variable costs are $1 per jar. The product will be priced at $2 per jar. The plant will be depreciated straight-line over 5 years to a salvage value of zero. The opportunity cost of capital is 10 percent, and the tax rate is 40 percent.

a. What is project NPV under these base-case assumptions?

NPV is calculated by finding the present value of each cash flow, including both cash inflows and outflows, discounted at the firm's cost of capital.

Expected cash outflows = $5,000,000

Expected cash inflow per year

Sales (6,000,000 x $2) $12,000,000
Less: Variable costs (6,000,000 x $1) $ 6,000,000
Contribution Margin $ 6,000,000
Less: Fixed costs $ 2,000,000
Depreciation Expense ($5,000,000/5 years) $ 1,000,000
Income before ...

Solution Summary

This solution is comprised of a detailed explanation to answer the request of the assignment in text file, using equations and calculations to determine NPV and price per jar.

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