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Arnold is contemplating for purchasing $280000 a machine which he will use to produce 50000 units of a product per annum for 5 years. This product will be sold for $10 each and unit variable cost are expected to be $6. Incremental fixed cost will be $70000 per annum for production cost and $25000 per annum for selling and admin cost. Arnold has a required return of 10% per annum
By how many units must be the estimate of production and sales volume fall for the project to be regarded as not worthwhile
a)2875
b)7785
c)8115
d)12315Sir correct ans is B and i have also computed at option B the NPV of project will be 0. However as the question ask for the project not to be worthwhile, in other words it mean rejection of project ,so shouldn’t it be at option C or D , as NPV at both of these options would be negative?
At present the machine is worthwhile.
It will remain worthwhile until the NPV falls to zero – if it fell any further then it would not be worthwhile. So it only needs to fall by 7785 units to start being not worthwhile and this is what the question is asking for.
You may not like the wording, but it is reasonable and certainly wording that stands to be used in the exam.
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