X company is planning to launch a new product. Market research, costing $ 190,00

Question

X company is planning to launch a new product. Market research, costing $ 190,000, has already been done indicating that the product will be successful for four years, but to insure success, the company plans to undertake an immediate advertising compaign that will also cost $190,000. New manufacturing equipment will have to be purchased - it will cost $300,000 and have a disposal value at the end of four years of $160,000. It is expected that profits from sales of the product will be $167,000 in each of the first two years and $120,000 in each of the last two years. Assuming a discount rate of 5%, what is the net present value of launching the new product?

Please show the step by step. Thanks.

Explanation / Answer

Working notes:

(1) Previous market research cost of $190,000 is already spent & is a sunk cost. This is ignored from NPV calculations.

(2) First cost = New campaign cost + equipment cost = $(190,000 + 300,000) = $490,000

(3) NPV is the sum of all discounted cash inflows & outflows (= Net annual benefit).

Year First cost Annual profit Salvage Net Annual benefit (NAB) Discount factor @5% Discounted NAB (A) (B) (C) (D)=(B)+(C)-(A) (E) (D)x(E) 0 490000 -490000 1.0000 -490000 1 167000 167000 0.9524 159048 2 167000 167000 0.9070 151474 3 120000 120000 0.8638 103661 4 120000 160000 280000 0.8227 230357 NPV ($) = 154539

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