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A company has calculated the NPV of a new project as follows:
Present value
($’000) Sales revenue 4,000
Variable costs (2,000) Fixed costs (500)
Corporation tax at 20% (300)
Initial outlay (1,000)
NPV 200
What is the sensitivity of the project decision to a change in sales volume? 12.5% 6.3% 10.0% 5.0sir what i did not understand from the answers at the back of the exam kit is that why did we eliminate tax from contribution. because we learned that the sensitivity analysis formula is supposed to be =npv/pv of contribution.
A lease versus buy evaluation has been performed. The management accountant performed the calculation by taking the saved initial outlay and deducting the tax-adjusted lease payments and the lost capital allowances. The accountant discounted the net cash flows at the post-tax cost of borrowing. The resultant net present value (NPV) was positive.
Assuming the calculation is free from arithmetical errors, what would the conclusion for this decision be?
Lease is better than buy
Buy is better than lease
A further calculation is needed
The discount rate was wrong so a conclusion cannot be drawnaccording to the exam kit the correct answer is lease is better. but i have a doubt because the question says initial outlay, which means initial investment if i am not wrong, in calculation of NPV for financial or operating lease we donot consider initial investment right?. so how come lease is better option is correct and not buy is better than lease?
also can you explain how the other two options are incoreectFirst question:
For the sensitivity we take the NPV / the PV of whatever we are looking at the sensitivity of
If we are looking at the sensitivity of the sale volume, then the contribution will change and therefore so will the tax. Therefore we take the PV of the after tax contribution.
Second question:
For lease and buy decisions we are comparing the leasing flows (which do not include the initial cost or the tax saving on the capital allowances) with the buying flows (which do include the initial cost and the tax savings on the capital allowances).
What this question says that the accountant has done is that instead of setting up two sets of cash flows and comparing the two PV’s, he has simply looked at the difference between the two sets of flows and so arrived at the NPV of the difference. That is fine and leads to exactly the same conclusion.
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