Applied Nanotech is thinking about introducing a new surface cleaning machine. T

Question

Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 15 units per year at $305,000 net cash flow per unit for the next five years. The engineering department has come up with the estimate that developing the machine will take a $15 million initial investment. The finance department has estimated that a 16 percent discount rate should be used.

A. What is the base-case NPV?

b. If unsuccessful, after the first year the project can be dismantled and will have an aftertax salvage value of $11 million. Also, after the first year, expected Cashflows will be revised up to 20 units per year or to 0 units, with equal probability. What is the revised NPV?

Please show all workings.

Explanation / Answer

(1) Base case NPV

Annual cash flow for 15 units = $305,000 x 15 = $4,575,000

NPV ($) = - 15,000,000 + 4,575,000 x PVIFA (16%, 5 years)

= - 15,000,000 + 4,575,000 x 3.2743 [From PVIFA Table]

= - 15,000,000 + 14,979,922.5

= 20,077.5

(b)

Expected value of number of annual units = 50% x 20 + 50% x 0 = 10 units per year

Expected cash flow per year, years 1-5 = 10 x $305,000 = $3,050,000

For annual expected cash flow of $4,575,000 per year for 5 years, NPV is negative. So it's obvious that expected NPV with this revised situation will be negative, therefore, the project will remain unsuccessful. The salvage value will have to be counted.

Year 1 expected cash flow = $(11,000,000 + 4,575,000) = $15,575,000

Revised NPV is computed as follows.

So, revised NPV is $1,452,145.

Year Cash Flow ($) Discount Factor @16% Discounted Cash Flow ($) 0 -150,00,000 1.0000 -150,00,000 1 155,75,000 0.8621 134,26,724 2 30,50,000 0.7432 22,66,647 3 30,50,000 0.6407 19,54,006 4 30,50,000 0.5523 16,84,488 5 30,50,000 0.4761 14,52,145 Revised (Expected) NPV ($) = 14,52,145

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