- This topic has 3 replies, 2 voices, and was last updated 14 years ago by
.
- Posts
What is the appropriate calculation method shall adopt? seem this was a bit deal with mathematic knowledge?
I am not sure what you mean about mathematical knowledge.
He wanted you to calculate the NPV (because it said ‘decision on financial grounds’ and he gave you the cash flows and the cost of capital).
The question is about what is the minimum contribution to sales rate in order to achieve NPV = 0
OK – it needs a little maths, but only a little.
The way I would have done it is this.
At present the NPV is -427 (I will work in thousands, which would be fine for the exam).
The only thing that we change is the contribution.At the moment, the PV of the contribution is (2000 x .893) + (4500 x .797) + (2500 x .712) = 7153
To get an NPV of zero, the PV of the contribution needs to increase by 427
In percentage terms, this means that the contribution needs to increase by 427/7153 x 100% = 5.97%
Currently the contribution to sales ratio is 50%, so a 5.97% increase in this gives 50 x (1.0597) = 52.985% (the same as his answer).
If the CS ratio is any higher than this then the NPV will be positive and the project will be financially viable.
- You must be logged in to reply to this topic.