[kaaliannie]

Abbey Trading Company is considering a project that is susceptible to risk. An initial investment of £90,000 will be followed by three years each with the following expected cash flows (there is no inflation or tax):

£ £
Annual sales (volume of 100,000 units multiplied by estimated sales price of £2) - 200,000

Annual costs (volume of 100,000 units multiplied by unit labour, material & other costs respectively)

Labour 100,000
Material 40,000
Other 10,000
150,000
200,000 - (150,000)
50,000

The initial investment consists of £70,000 in machines, which have a zero scrap value at the end of the three-year life of the project and £20,000 in additional working capital which is recoverable at the end. The discount rate is 10%.

a. Calculate the NPV of the project and explain what it means.
b. Conduct a sensitivity analysis on the following four variables and explain which one of them is the most significant in affecting the profitability of the project (assuming all other variables remain constant). 1. sales price; 2. Labour costs
3. material costs; 4. Sales volume

A basic exam question given by my tutor and I've had a complete mind blank..

Any help would be great, even a starting step!

[makaveli33]

(Original post by kaaliannie)
Abbey Trading Company is considering a project that is susceptible to risk. An initial investment of £90,000 will be followed by three years each with the following expected cash flows (there is no inflation or tax):

£ £
Annual sales (volume of 100,000 units multiplied by estimated sales price of £2) - 200,000

Annual costs (volume of 100,000 units multiplied by unit labour, material & other costs respectively)

Labour 100,000
Material 40,000
Other 10,000
150,000
200,000 - (150,000)
50,000

The initial investment consists of £70,000 in machines, which have a zero scrap value at the end of the three-year life of the project and £20,000 in additional working capital which is recoverable at the end. The discount rate is 10%.

a. Calculate the NPV of the project and explain what it means.
b. Conduct a sensitivity analysis on the following four variables and explain which one of them is the most significant in affecting the profitability of the project (assuming all other variables remain constant). 1. sales price; 2. Labour costs
3. material costs; 4. Sales volume

A basic exam question given by my tutor and I've had a complete mind blank..

Any help would be great, even a starting step!

Hmmm....I imagine this is Accounting, I may be wrong.

I only know NPV.

This is Net Present Value....

To break it down, you need to calculate....

The difference between, "the amount of cash, inflow minus outflow", this is net cash flow.

It is shown as the formula below...

R@t / (1 + i)t

R = the net cash flow
t = time
1 = a number, lol
i = the discount rate

For the explanation of net present value, I suggest you look at my sources on NPV section explained.

Hope this helps, but I would like to point out I may be wrong, but I am trying to help, I hope this gives you an idea.

Look at each figure and use it to link it to the equation of NPV, you may need to look carefully not to make any mistakes with the project sheet. You may need to do some adding or subtracting to work out the full extent of the sum.

Sources:

http://www.businessdictionary.com/de...value-NPV.html
http://en.wikipedia.org/wiki/Net_present_value