26))

In a slow year, Deutsche Burgers will produce 3.2 million hamburgers at a total cost of $4.6 million. In a good year,
it can produce 6.2 million hamburgers at a total cost of $6.4 million. What are the variable and fixed costs of
hamburger production? (Enter your answers in dollars not in millions. Round "Variable cost" to 2 decimal
places.)

Variable cost 0.60 ± 1% per burger

$
Fixed cost 2,680,000 ± 1%
$

Explanation:

The extra 3.2 million burgers increase total costs by $1.8 million.
Therefore, variable cost $1.8 million/3 million = $0.60 per burger.
Fixed costs must then be $2.68 million, since the first 3.2 million burgers result in a total cost of $4.6 million.

VC+3.2*.6=4.6

27))

project currently generates sales of $12.5 million, variable costs equal to 40% of sales, and fixed costs of $3.9
million. The firm’s tax rate is 20%.

a. What are the effects on the after-tax profits and cash flow, if sales increase from $12.5 million to $13.2 million.
(Input all amounts as positive values. Do not round intermediate calculations. Enter your answers in
millions rounded to 3 decimal places.)

0.336 ± 1%
After-tax profit increased by $ million.
0.336 ± 1%
Cash flow increased by $ million.

b. What are the effects on the after-tax profits and cash flow, if variable costs increase to 50% of sales. (Input all
amounts as positive values. Do not round intermediate calculations. Enter your answers in millions
rounded to 3 decimal places.)

1.000 ± 1%
After-tax profit decreased by $ million.
1.000 ± 1%
Cash flow decreased by $ million.

Explanation:

a. (Revenue − expenses) changes by $0.7 million − $0.28 million = $0.42 million.

After-tax profits increase by $0.42 million × (1 − 0.2) = $0.336 million.
 Because depreciation is unaffected, cash flow changes by the same amount.
b. Expenses increase from $5 million to $6.25 million.
After-tax income and cash flow decrease by:
$1.25 million × (1 − 0.2) = $1 million

A project currently generates sales of $11 million, variable costs equal to 50% of sales, and fixed costs of $2.4
million. The firm’s tax rate is 30%.
The project will last for 10 years. The discount rate is 14%.

a-1. What is the effect on project NPV, if sales increase from $11 million to $11.4 million? (Do not round
intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

Change in cash flow 0.730 ± 1%

$ million

a-2. What is the effect on project NPV, if variable costs increase to 60% of sales? (Do not round intermediate
calculations. Enter your answer in millions rounded to 3 decimal places.)

Change in cash flow 4.016 ± 1%

$ million

b. If project
NPV under
the base-case
scenario is
$2.4 million,
how much
can fixed
costs
increase
before NPV
turns
negative?
(Do not
round
intermediate
calculations.
Enter your
answer in
dollars not
in millions.
Round you
answer to
the nearest
dollar
amount.)

Increase in fixed cost 657,304 ± 1%

$
 c. How much can fixed costs increase before accounting profits turn negative? (Do not round intermediate
calculations. Enter your answer in millions rounded to 2 decimal places.)

Increase in fixed cost 2.17 ± 1%

$ million

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.
The 14%, 10-year annuity factor is:
The effect on NPV equals the change in CF × 5.21612.
a-1.
$0.14 million × 5.21612 = $0.73 million
a-2.
$0.77 million × 5.21612 = $4.016 million
b.
Fixed costs can increase up to the point at which the higher costs (after taxes) reduce NPV by $2.4 million:
Increase in fixed costs × (1 − T) × annuity factor (14%, 10 years) = $2.4 million
Increase in fixed costs × (1 − 0.3) × 5.21612 = $2.4 million
Increase in fixed costs = $657,304
c.
Accounting profits are currently ($11 − $5.5 − $2.4) million × (1 − 0.3) = $2.17 million.
Fixed costs can increase by this amount before pretax profits are reduced to zero.

30)) Emperor’s Clothes Fashions can invest $6 million in a new plant for producing invisible makeup. The plant
has an expected life of 5 years, and expected sales are 7 million jars of makeup a year. Fixed costs are $2.5 million
a year, and variable costs are $2.6 per jar. The product will be priced at $3.4 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%, and the tax rate is 30%.

a. What is project NPV under these base-case assumptions? (Do not round intermediate calculations. Enter
your answer in millions rounded to 2 decimal places.)

NPV 3.59 ± 1%
$ million

b. What is NPV if variable costs turn out to be $2.7 per jar? (Do not round intermediate calculations. Enter
your answer in millions rounded to 2 decimal places.)

NPV 1.73 ± 1%
$ million

c. What is NPV if fixed costs turn out to be $2.2 million per year? (Do not round intermediate calculations.
Enter your answer in millions rounded to 2 decimal places.)

NPV 4.39 ± 1%
$ million

d. At what price per jar would project NPV equal zero? (Enter your answer in dollars not in millions. Do not
 round intermediate calculations. Round your answer to 2 decimal places.)

Price 3.22 ± 1%
$ per jar

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.

Revenue = price × quantity = $3.4 × 7 million = $23.8 million

Expense = variable cost + fixed cost = ($2.6 × 7 million) + $2.5 million = $20.7 million
Depreciation expense = $6 million/5 years = $1.2 million per year
Cash flow = (1 − T) × (revenue − expenses) + (T × depreciation)
= [0.7 × ($23.8 million − $20.7 million)] + (0.3 × $1.2 million) = $2.53 million
a.
NPV = −$6 million + [$2.53 million × annuity factor (10%, 5 years)]
NPV=investment+(cash flow x annuity factor)

= −$6 million + $2.53 million

b.
If variable cost = $2.7, then expenses increase to:
($2.7 × 7 million) + $2.5 million = $21.4 million
CF = [0.7 × ($23.8 million − $21.4 million)] + (0.3 × $1.2 million) = $2.04 million
NPV = −$6 million + [$2.04 million × annuity factor (10%, 5 years)]

= −$6 million + $2.04 million

c.
If fixed costs = $2.2 million, expenses fall to:
($2.6 × 7 million) + $2.2 million = $20.4 million
Cash flow = [0.7 × ($23.8 million – $20.4 million)] + (0.3 × $1.2 million) = $2.74 million
NPV = −$6 million + [$2.74 million × annuity factor (10%, 5 years)]

= −$6 million + $2.74 million

d.
Call P the price per jar. Then:
Revenue = P × 7 million
Expense = ($2.6 × 7 million) + $2.5 million = $20.7 million
Cash flow = [(1 − 0.3) × (7P − 20.7)] + (0.3 × 1.2) = 4.9P − 14.19
NPV = −6 + [(4.9P − 14.19) × annuity factor (10%, 5 years)]

= −6 + (4.9P − 14.19)

= −6 + [(4.9P − 14.19) × 3.791] = −59.7913 + 18.5749P = 0P = $3.22 per jar

31))The most likely outcomes for a particular project are estimated as follows:
Unit price: $60
Variable cost: $40
Fixed cost: $420,000
Expected sales: $47,000units per year
However, you recognize that some of these estimates are subject to error. Suppose that each variable may turn out
to be either 10% higher or 10% lower than the initial estimate. The project will last for 10 years and requires an
initial investment of $2.1 million, which will be depreciated straight-line over the project life to a final value of
zero. The firm’s tax rate is 40% and the required rate of return is 12%.
a. What is project NPV in the “best-case scenario,” that is, assuming all variables take on the best possible value?
(Negative amount should be indicated by a minus sign. Enter your answer in dollars not in millions. Do
not round intermediate calculations. Round your answer to the nearest dollar amount.)
NPV 2,351,246 ± 1%
$
b. What is project NPV in the worst-case scenario? (Negative amount should be indicated by a minus sign.
Enter your answer in dollars not in millions. Do not round intermediate calculations. Round your answer
to the nearest dollar amount.)
NPV -1,757,596 ±
$

rev: 08_08_2012

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.

a.&b.

Most Likely Best Case Worst Case

Price $60 $66 $54
Variable cost $40 $36 $44
Fixed cost $420,000 $378,000 $462,000
Sales 47,000 units 51,700 units 42,300 units

Cash flow = [(1 − T) × (revenue − cash expenses)] + (T × depreciation)

Depreciation expense = $2.1 million/10 years = $210,000 per year
Best-case CF = 0.60 × [51,700 × ($66 − $36) − $378,000] + (0.40 × $210,000) = $787,800
Worst-case CF = 0.60 × [42,300 × ($54 − $44) − $462,000] + (0.40 × $210,000) = $60,600

12%, 10-year annuity factor =

Best-case NPV = (5.65022 × $787,800) − $2,100,000 = $2,351,246

Worst-case NPV = (5.65022 × $60,600) − $2,100,000 = −$1,757,596

32)) Dime a Dozen Diamonds makes synthetic diamonds by treating carbon. Each diamond can be sold for $140.
The materials cost for a standard diamond is $40. The fixed costs incurred each year for factory upkeep and
administrative expenses are $210,000. The machinery costs $1.8 million and is depreciated straight-line over 10
years to a salvage value of zero.

a. What is the accounting break-even level of sales in terms of number of diamonds sold?

Break-even sales 3,900 ± 1%

b. What is the NPV break-even level of sales assuming a tax rate of 30%, a 10-year project life, and a discount rate
 of 14%? (Do not round intermediate calculations. Round your answer to the nearest whole number.)

Break-even sales 6,258 ± 1%

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.

a.

Each dollar of sales generates $1.00 of pretax profit. Depreciation expense is $180,000 per year, and fixed costs are
$210,000. Therefore:
Accounting break-even revenue = ($210,000 + $180,000)/1.00 = $390,000
The firm must sell 3,900 diamonds annually.

b.

Let Q = the number of diamonds sold.

Cash flow = [(1 − 0.30) × (revenue − expenses)] + (1.80 × depreciation)
= [0.70 × (140Q − 40Q − 210,000)] + (0.30 × 180,000)
= 70Q − 93,000
14%, 10-year annuity factor =

Therefore, for NPV to equal zero:

(70Q − 93,000) × 5.21612 = $1,800,000Q = 6,258 diamonds per year

33))

Modern Artifacts can produce keepsakes that will be sold for $60 each. Nondepreciation fixed costs are $1,400 per
year and variable costs are $30 per unit.

a. If the project requires an initial investment of $5,000 and is expected to last for 5 years and the firm pays no
taxes. The initial investment will be depreciated straight-line over 5 years to a final value of zero, and the
discount rate is 12%. What are the accounting and NPV break-even levels of sales? (Do not round
intermediate calculations. Round your answers to the nearest whole number.)

Accounting break-even levels of sales 80 ± 1%

units
NPV break-even levels of sales 93 ± 1%
units

b. What will be the accounting and NPV break-even levels of sales, if the firm's tax rate is 35%? (Do not round
intermediate calculations. Round your answers to the nearest whole number.)

Accounting break-even levels of sales 80 ± 1%

units
NPV break-even levels of sales 100 ± 1%
units
Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.
a.
Variable cost = 50% of sales revenue
Therefore, additional profit per $1 of additional sales = $0.50.
Depreciation expense = $5,000/5 = $1,000 per year
Break-even level of sales =

Fixed costing including depreciation $1,400 + $1,000

= = $4,800 per year
Additional profit from each additional dollar of sales 0.50

This sales level corresponds to a production level of $4,800/$60 per unit = 80 units.
To find the NPV break-even level of sales, first calculate cash flow.
With no taxes: Cash flow = (0.50 × sales) − $1,400

The 12%, 5-year annuity factor is:

Therefore, if project NPV equals zero:

PV(cash flows) − investment = 0
[3.60478 × (0.50 × sales) − $1,400] − $5,000 = 0
(1.80239 × sales) − 5,046.69 − $5,000 = 0 sales = $5,574
This sales level corresponds to a production level of $5,574/$60 = almost 93 units.

b.

Now taxes are 35% of profits. Accounting break-even is unchanged since taxes are zero when profits = 0.
To find NPV break-even, recalculate cash flow:
Cash flow = [(1 − T) × (revenue − cash expenses)] + (T × depreciation)
= 0.65 × [(0.50 × sales) − $1,400] + (0.35 × $1,000) = (0.3250 × sales) − 560
The annuity factor is 3.60478, so we find NPV as follows:
3.60478 × [(0.3250 × sales) − 560] − $5,000 = 0 sales = $5,991
This corresponds to production of $5,991/$80 = almost 100 units.

34))

silver mine can yield 18,000 ounces of silver at a variable cost of $38 per ounce. The fixed costs of operating the
mine are $45,000 per year. In half the years, silver can be sold for $54 per ounce; in the other years, silver can be
sold for only $27 per ounce. Ignore taxes.

a. What is the average cash flow you will receive from the mine if it is always kept in operation and the silver
always is sold in the year it is mined?

Average cash flow 0 ± 1%

$
b. Now suppose you can shut down the mine in years of low silver prices. Calculate the average cash flow from
the mine.

Average cash flow 121,500 ± 1%

$

Explanation:

a.
Average annual expenses = (18,000 × $38) + $45,000 = $729,000
Average annual revenue = 18,000 × (0.5 × $27) + 18,000 × (0.5 × $54) = $729,000
Average cash flow = revenue − expenses = $729,000 − $729,000 = $0

b.
If you can shut down the mine 50% of the time, CF in the low-price years will be zero. In the remaining years,
Average cash flow = $486,000 − (0.5 × $729,000) = $121,500
(We assume fixed costs are incurred only if the mine is operating. The fixed costs do not rise with the amount of
silver extracted, but they are not incurred unless the mine is in production.)

35))

An auto plant that costs $200 million to build can produce a line of flexfuel cars that will produce cash flows with a
present value of $280 million if the line is successful but only $90 million if it is unsuccessful. You believe that the
probability of success is only about 40%. You learn whether the line is successful immediately after building the
plant.

a-1. Calculate the expected NPV. (Negative amount should be indicated by a minus sign. Enter your answer
in millions rounded to 1 decimal place.)

Expected NPV -34.0 ± 1%

$ million

a-2. Would you build the plant?

No

Suppose that the plant can be sold for $150 million to another automaker if the auto line is not successful.

b-1. Calculate the expected NPV. (Negative amount should be indicated by a minus sign. Enter your answer
in millions rounded to 2 decimal places.)

Expected NPV 2.00 ± 1%

$ million

b-2. Would you build the plant?

Yes

rev: 07_27_2012

Explanation:
a.
Expected NPV = [0.40 × ($280 − $200)] + [0.60 × ($90 − $200)] = −$34.0 million
Therefore, you should not build the plant.

b.
Now the worst-case value of the installed project is $150 million rather than $40 million. Expected NPV increases
to a positive value:
[0.40 × ($280 − $200)] + [0.60 × ($150 − $200)] = $2.00 million
Therefore, you should build the plant

36))

Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to
be able to sell 62,000 units a year at a price of $60 each. If the new product is a bust, only 42,000 units can be sold
at a price of $55. The variable cost of each ball is $30, and fixed costs are zero. The cost of the manufacturing
equipment is $7.9 million, and the project life is estimated at 10 years. The firm will use straight-line depreciation
over the 10-year life of the project. The firm’s tax rate is 30%, and the discount rate is 12%.
a-1. If each outcome is equally likely, what is expected NPV? (Negative amount should be indicated by a
minus sign. Do not round intermediate calculations. Enter your answer in dollars not in millions.
Round your answer to the nearest dollar amount.)

Expected NPV -806,145 ± 1%

$

a-2. Will the firm accept the project?

No

b-1. Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $7.1 million
if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the
first year of sales. What is expected NPV? (Negative amount should be indicated by a minus sign. Do not
round intermediate calculations. Enter your answer in dollars not in millions. Round your answer to
the nearest dollar amount.)

Expected NPV 55,882 ± 1%

$

b-2. Does the option to abandon change the firm’s decision to accept the project?
Yes

rev: 08_14_2012

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the
actual calculations.

a.

Optimistic Pessimistic
Price $60 $55
Sales 62,000units 42,000units
Variable cost $30 $30
Cash flow = [(1 − T) × (revenue − cash expenses)] + (T × depreciation)

Optimistic CF = 0.70 × [($60 − $30) × 62,000] + (0.30 × $790,000) = $1,539,000

NPV = −$7,900,000 + [$1,539,000 × annuity factor (12%, 10 years)]

Pessimistic CF = 0.70 × [($55 − $30) × 42,000] + (0.30 × $790,000) = $972,000

NPV = −$7,900,000 + [$972,000 × annuity factor (12%, 10 years)]

Expected NPV = (0.5 × $795,693) + [0.5 × (−$2,407,983)] = −$806,145

The firm will reject the project.

b.

If the project can be abandoned after 1 year, then it will be sold for $7.1 million. (There will be no taxes on the sale
because this also is the depreciated value of the equipment.)

Cash flow (at t = 1) = cash flow from project + sales price:

$972,000 + $7,110,000 = $8,082,000

$8,082,000
PV = = $7,216,071
1.12

NPV in the abandonment scenario is:

$7,216,071 − $7,900,000 = −$683,929
Note that this NPV is not as disastrous as the result in part (a).
Expected NPV is now positive:
(0.5 × $795,693) + [0.5 × (−$683,929)] = $55,882
Because of the abandonment option, the project is now worth pursuing

37))