Knight Shades Inc. is considering adding new line of sunglasses to their designer series. The glasses will sell for $1,100 per pair and have a variable cost of $400 per unit. The company has spent $101,000 for a marketing study that estimates the company will sell 74,000 sunglasses per year for seven years. The fixed costs each year to produce the sunglasses will be $5,040,000. The company has also spent $706,000 on research and development for the new glasses. The new plant and equipment will cost $12,000,000 at start-up and will be depreciated on a straight-line basis to zero over the seven years. At the end of the seven years the plant and equipment will be worthless. The new sunglasses will also require an increase in net working capital of $664,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 9 percent. The marketing study also estimates that introducing the new sunglasses will reduce sales of the company's high-priced sunglasses by 18,000 units. The high-priced glasses sell at $1,800 and have variable costs of $700. The study also estimates that the company will increase sales of its cheap sunglasses by 13,000 units. The cheap sunglasses sell for $600 and have variable costs of $200 per unit. Knight Shades Inc. estimates the project's NPV to be $88,266,254.86, but would like to know the sensitivity of NPV to changes in the price of the new sunglasses and the quantity of new sunglasses sold. Note: you may want to verify the base-case NPV to make sure you're setting up the problem correctly.
Knight Shades Inc. is considering adding new line of sunglasses to their designer series. The glasses will sell for $1,100 per pair and have a variable cost of $400 per unit. The company has spent $101,000 for a marketing study that estimates the company will sell 74,000 sunglasses per year for seven years. The fixed costs each year to produce the sunglasses will be $5,040,000. The company has also spent $706,000 on research and development for the new glasses. The new plant and equipment will cost $12,000,000 at start-up and will be depreciated on a straight-line basis to zero over the seven years. At the end of the seven years the plant and equipment will be worthless. The new sunglasses will also require an increase in net working capital of $664,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 9 percent. The marketing study also estimates that introducing the new sunglasses will reduce sales of the company's high-priced sunglasses by 18,000 units. The high-priced glasses sell at $1,800 and have variable costs of $700. The study also estimates that the company will increase sales of its cheap sunglasses by 13,000 units. The cheap sunglasses sell for $600 and have variable costs of $200 per unit. Knight Shades Inc. estimates the project's NPV to be $88,266,254.86, but would like to know the sensitivity of NPV to changes in the price of the new sunglasses and the quantity of new sunglasses sold. Note: you may want to verify the base-case NPV to make sure you're setting up the problem correctly.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Concept explainers
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Question
Transcribed Image Text:Knight Shades Inc. is considering adding new line of sunglasses to their designer series.
The glasses will sell for $1,100 per pair and have a variable cost of $400 per unit. The
company has spent $101,000 for a marketing study that estimates the company will sell
74,000 sunglasses per year for seven years.
The fixed costs each year to produce the sunglasses will be $5,040,000. The company
has also spent $706,000 on research and development for the new glasses. The new
plant and equipment will cost $12,000,000 at start-up and will be depreciated on a
straight-line basis to zero over the seven years. At the end of the seven years the plant
and equipment will be worthless. The new sunglasses will also require an increase in net
working capital of $664,000 that will be returned at the end of the project. The tax rate
is 40 percent, and the cost of capital is 9 percent.
The marketing study also estimates that introducing the new sunglasses will reduce
sales of the company's high-priced sunglasses by 18,000 units. The high-priced glasses
sell at $1,800 and have variable costs of $700. The study also estimates that
the company will increase sales of its cheap sunglasses by 13,000 units. The cheap
sunglasses sell for $600 and have variable costs of $200 per unit.
Knight Shades Inc. estimates the project's NPV to be $88,266,254.86, but would like to
know the sensitivity of NPV to changes in the price of the new sunglasses and the
quantity of new sunglasses sold.
Note: you may want to verify the base-case NPV to make sure you're setting up the
problem correctly.
Transcribed Image Text:Required:
(a)What is the sensitivity of the NPV to changes in the price of the new sunglasses?
Note: In your economics classes you learned that sensitivity (elasticity) is defined as
the percent change in one variable due to a percent change in another variable.
Hence, it is easiest to estimate the sensitivity by re-calculating the NPV if price
increases by 1%. (Do not round your intermediate calculations.)
(Click to select) ♥
(b)What is the sensitivity of the NPV to changes in the quantity sold? Calculate the
sensitivity by assuming sales increase by 1%. (Do not round your intermediate
calculations.)
v (Click to select)
-.2278
3.1622
-98.2278
201.7722
1.7722
Prov
7 of O
Noxt
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