Corporate Finance

214
Corporate Finance

Table contd.

Year Cash flow

2 128

3 180

4 389

5 365

6 342

7 307

8 1,068

*8th year cash flow includes salvage value of Rs 800 lac

NPV = –Rs 199.50

The sensitivity of NPV to changes in cash flows is shown in Exhibit 11.3. When cash flows drop by
10 percent, the project becomes unviable.
The end-result of the sensitivity analysis is a range of NPVs. The management should take the decision to
accept or reject the project, based on the riskiness of the project. Sensitivity analysis gives us the range of
NPV but it does not tell us which NPV is more likely to occur.

BREAK-EVEN ANALYSIS

As the name suggests, break-even point (BEP) refers to the level of activity at which profitability is zero.
Depending on whether the measure of profitability is net income or NPV, the breakeven point is called
accounting breakeven point or financial breakeven point respectively. At the accounting BEP, net income is
zero. The firm neither makes profit nor loss.
Break-even point is calculated for a single year:

Sales revenue = Total costs

(No.of units sold × Selling price per unit) = Fixed cost + Total variable costs

= Fixed cost + (Variable cost per unit × No. of units sold)

Selling price per –unit Variable cost per unit

Fixedcost

No. of units solf=

Exhibit 11.3 Sensitivity of NPV to cash flows

Year 1 1.1 1.2 0.9 0.8

0 –1,410 –1,410 –1,410 –1,410 –1,410

1 128 140.80 153.6 115.20 102.4

2 180 198.00 216 162.00 144

3 389 427.90 466.8 350.10 311.2

4 365 401.50 438 328.50 292

5 342 376.20 410.4 307.80 273.6

6 307 337.70 368.4 276.30 245.6

7 288 316.80 345.6 259.20 230.4

Exhibit 11.3 contd.