Convincing Features
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SBS Corporation has developed a new industrial detergent that can be used in motor vehicle garages. It would cost RM1.2 million to buy the equipment necessary to manufacture the blenders, and initially, it would require net operating working capital equal to 10% of the 1st year sales amount. Annual net operating working capital will be at 15% of the next year’s sales. The project would have a life of 5 years. If the project is undertaken, it will be operated for the entire 5 years.
The firm believes it could sell 150,000 units per year. The detergents would sell for RM10 per unit. After the first year, SBS intends to increase the sales price by 2% annually.
The variable cost is RM4.50 per unit and will increase at an inflation rate of 5%. The company’s fixed costs would be RM320,000 in Year 1 and would also increase at a rate of 3% annually.
The equipment would be depreciated over a 5-year period, using the straight-line method. The annual depreciation will be calculated based on a salvage value of the equipment at the end of the project’s 5- year life of RM120,000. The company, however, estimated the machine could be sold as scrap for RM80,000. The corporate tax rate is 25%. The weighted average cost of capital is 13%.
1. Develop a spreadsheet model and use it to find the project’s NPV, IRR, and payback.
2. Conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, number of units sold the variable costs per unit, fixed costs, and the cost of capital. Set these variables’ values at 10% above and 10% below their base-case values. Include a graph in your analysis.
3. Conduct a scenario analysis. Assume that the best-case condition is with no increase in the sales price, a 5% increase in the number of units sold, and a 3% decrease in the variable cost per unit. All other variables remain the same. For the worst-case condition, there will be a 5% decrease in units sold, a 2% decrease in unit price and a 3% increase in the variable cost per unit. The best-case condition has a probability of 30% that it will happen, while the worst-case condition has 20%, and the base case is assumed to have the remaining probability of 50%. Determine the expected NPV, the standard deviation of the NPV and the project’s coefficient of variation NPV.
4. Based on your analysis, would you recommend that the project be accepted? What added advise and special attention would you give to the company regarding the project?
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