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You are evaluating a project which costs $720,000, has a four-year life, and no salvage value. Depreciation is straight-line and the half year rule does not apply. Sales are projected at 190 units per year; price per unit will be $21,000, variable cost per unit will be $15,000 and fixed costs will be $225,000 per year. Based on your experience, you believe the unit sales, variable cost and the fixed cost projections given here are probably accurate to within ± 10 percent. The required return on the project is 15 percent and the tax rate is 35 percent.
(a) Calculate the operating cash flow (OCF) and net present value (NPV) for the base-case, best-case and worst-case scenarios.
(b) Suppose that the probability of the base-case scenario is twice the probability of either the worst-case scenario or the best-case scenario. Should the project be accepted? Why?
(c) How sensitive is the base-case NPV to changes in fixed costs? Illustrate your answer assuming that fixed costs increase from $225,000 to $230,000.
(d) What is the base-case accounting break-even sales level for this project.
(e) Calculate the degree of operating leverage (DOL) for the base-case scenario. How do you interpret this number?
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