X Company is planning to launch a new product. Market research, costing $200,000

Question

X Company is planning to launch a new product. Market research, costing $200,000, 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 campaign that will also cost $200,000. New manufacturing equipment will have to be purchased - it will cost $400,000 and have a disposal value at the end of four years of $13,000. It is expected that profits from sales of the product will be $156,000 in each of the first two years and $101,000 in each of the last two years. Assuming a discount rate of 5%, what is the net present value of launching the new product?

Explanation / Answer

NOTE:

1) As the market research cost has already been undertaken, it is sunk cost and has not been considered for the calculation of NPV of the project.

2) As there is no tax, there will be no tax advantage of depreciation in generating the cash flow for the company. Threfore the cash flow of the company will be same as the net profit of the company in a particular year.

year cash flow Discount factor @ 5% PV of cash flow 0 -$400000 1 -$400000 0 -200000 1 -200000 1 156000 0.952 148571 2 156000 0.907 141497 3 101000 0.864 87248 4 101000 0.823 83093 4 13000 0.823 10695 NPV -$128896

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