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Hi Cath. i am really struggling with some of these decision making questions…. Am I missing something or is it just the nature of questions I am doing?
Question.
An education authority is considering the implementation of a CCTV system. details of the project are below:1. Life of project 5 years
2. Initial cost 750,000
Annual Savings:
Labor cost- 20,000
other costs- 5,000
cost of capital 15% per annumQuestion. The percentage change in the annual labor cost savings that could occur before the project ceased viable is?
Hi Abz
I think some of your concern is exam panic! – I think you are doing great and working really hard from what Ive seen so far!!
This is a standard sensitivity analysis problem meaning we’d use the formula:
sensitivity % of project variable = NPV/ PV of project variable x 100
It tells you by how much the variable – e.g. labour costs would need to change before the project was no longer viable.
Only problem here is this project is not viable to start with – if the machine costs $750,000 – its not going to be worthwhile for 5 years of savings of just 25,000 per year – that doesnt begin to make up for the initial cost of 750,000 even before we discount. Therefore we would have a non-viable negative NPV in our sensitivity calc which is illogical.
If your figures are definitely correct then it must be a mistake in the question – maybe an extra zero has been added or is missing from one of the cashflows?
Kind Regards
Cath
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