1. Melbourne Metal is considering becoming a supplier oftransmission housings. It would require buying a new forge thatwould cost $125,000 (including all setup costs) and is expected tolast five years. Let the asset life be the life of the project.

Melbourne Metal does a best guess (Base) study of their costsand revenues. They anticipate setting their price at p = $50 perunit and they estimate the annual demand is q = 2,500 – 10p.Variable costs (labour, materials, etc.) are estimated to be $15per unit. Total fixed costs (excluding depreciation of the forge)is estimated to be $10,000 per year.

Melbourne Metal uses the double declining balance method fordepreciation. The book balance at the start of year 1 is the$125,000. The depreciation in a year is a fixed percentage 0 < ?< 1 of the beginning of year book balance where the book balanceat the beginning of year n is the book balance at the end of year n– 1. The book balance at the end of year n, Bn = Bn-1 –depreciation that year. With the double declining balance method,the depreciation rate ? = 2 ? where N is the life of the project.The salvage value is assumed to the book balance at the end of theproject.

The tax rate is 40%. The MARR is 15%.

a. Set up an Income Statement and calculate annual net incomefor each year of the project. (15)

b. Set up a Statement of Cash Flows to calculate the net cashflows for the project. (10)

c. Find the net present value NPV of the project. (3)

d. Re-calculate NPV assuming the unit price is $10 higher andthen $10 lower. Recalculate NPV assuming the average variable costAVC is $10 higher and then $10 lower. Is the NPV of the projectmore sensitive to the unit price or the average variable cost?Explain. Note: Don’t do the % deviation I did in class since theseare dollar unit changes – just change the unit price or AVCdirectly. (10)

e. At what unit price will the project breakeven? (Don’t do thisby hand – five years is too complicated. If you don’t have Excel,try various prices until you get NPV close enough to zero).