Question 3. Blindfold Technologies Inc.

(BTI) is considering whether to introduce a new

line of hand scanners that can be used to copy material and then download it into a
computer. These scanners are expected to sell for an average price of $100 each, and the
company analysts performing the analysis expect that the firm can sell 100,000 units per
year at this price for a period of five years, after which time they expect demand for the
product to end as a result of a more advanced technology. In addition, the firm’s
management expects that variable costs will be $20 per unit, and fixed costs, not including
depreciation, are forecast to be $1,250,000 per year. To manufacture this product, BTI will
need to buy a computerized production machine for $10 million that has an expected life of
five years and no residual or salvage value. In addition, the firm expects it will have to
invest an additional $450,000 in working capital to support the new business. Other
pertinent information concerning the business venture is as follows:
Initial cost of the machine $10,000,000
Expected life 5 years

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Salvage value of the machine $0
Working-capital requirement $450,000

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Depreciation method Straight-line
Depreciation expense $2,000,000 per year

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Cash fixed costs
rs e $1,250,000 per year
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Variable cost per unit $20
Cost of capital 10%
Tax rate 20%
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a. Calculate the project’s NPV

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b. Determine the sensitivity of the project’s NPV to a 10% decrease in the number of units sold.
c. Determine the sensitivity of the project’s NPV to a 10% decrease in the cost per unit.
d. Determine the sensitivity of the project’s NPV to a 10% increase in the variable cost per unit.
e. Determine the sensitivity of the project’s NPV to a 10% increase in the annual fixed
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operating costs.
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f. Use the scenario analysis to evaluate the project’s NPV under the worst and best case
scenarios for the project’s value drivers. The values for the expected or base-case, worst-
case, and best-case scenarios are as follows:
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Expected or base case Worst case Best case

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Unit sales 100,000 70,000 130,000

Price per unit $100 $90 $120
Variable cost per unit $(22.50) $(25) $(18)
Cash fixed costs per year $(1,000,000) $(1,200,000) $(900,000)
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Depreciation expense $(2,000,000) $(2,000,000) $(2,000,000)

Answer:
a.
Year 0 1 2 3 4 5

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 Units sold 100,000 100,000 100,000 100,000 100,000
Sale price $100 $100 $100 $100 $100
10,000,00 10,000,00
Sales 10,000,000 0 0 10,000,000 10,000,000
Less: Variable cost 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
Less: Fixed costs 1,250,000 1,250,000 1,250,000 1,250,000 1,250,000
Less: Depreciation 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
EBIT 4,750,000 4,750,000 4,750,000 4,750,000 4,750,000
Less: Taxes 950,000 950,000 950,000 950,000 950,000
Plus: Depreciation 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
Operating CF 5,800,000 5,800,000 5,800,000 5,800,000 5,800,000
Change in NWC (450,000) - - - - 450,000
Change in CapEx (10,000,000) - - - - -
Free Cash Flow (10,450,000) 5,800,000 5,800,000 5,800,000 5,800,000 6,250,000
11,815,977.8
NPV 6

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PI 1.88

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IRR 48%

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Value Drivers Expected NPV Revised NPV % Change
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b. Unit Sales $11,815,977.86
$9,389,874 -21%
(−10%)
c. Price per unit $11,815,977.86
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$8,783,348 -26%
(−10%)
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d. Variable cost $11,815,977.86

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$11,209,452 -5%
(+10%)
e. Fixed cost $11,815,977.86
$11,436,899 -3%
(+10%)
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f. Worst case $11,815,977.86

$1,505,037.85 -87%
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Best case $11,815,977.86

$28,829,028.88 144%
is
Th
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