M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video
ID: 2654128 • Letter: M
Question
M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video game that requires a $7 million initial investment. M.V.P. expects a total annual operating cash flow of $1.3 million for the next 10 years. The relevant discount rate is 10 percent. Cash flows occur at year-end.
a. What is the NPV of the new video game?
b. After one year, the estimate of remaining annual cash flows will be revised either upward to $2.2 million or downward to $285,000. Each revision has an equal probability of occurring. At that time, the video game project can be sold for $2.6 million. What is the revised NPV given that the firm can abandon the project after one year?
Explanation / Answer
Answer
a. What is the NPV of the new video game?
Figures in $
Year
Initial investment
Annual operating cash flow
Total cash flow
Disc Rate : 10%
Present value of cash flow
A
B
C
D
E
A+B
C*D
0
-7000000
0
-7000000
1
-7000000.00
1
0
1300000
1300000
0.909091
1181818.18
2
0
1300000
1300000
0.826446
1074380.17
3
0
1300000
1300000
0.751315
976709.24
4
0
1300000
1300000
0.683013
887917.49
5
0
1300000
1300000
0.620921
807197.72
6
0
1300000
1300000
0.564474
733816.11
7
0
1300000
1300000
0.513158
667105.55
8
0
1300000
1300000
0.466507
606459.59
9
0
1300000
1300000
0.424098
551326.90
10
0
1300000
1300000
0.385543
501206.28
Net present value of New Video game
987937.24
b. After one year, the estimate of remaining annual cash flows will be revised either upward to $2.2 million or downward to $285,000. Each revision has an equal probability of occurring. At that time, the video game project can be sold for $2.6 million. What is the revised NPV given that the firm can abandon the project after one year?
Figures in $
Annual cash flow scenario
Amount
Probability
Annual Operating cash flows
A
B
A*B
Upward revision
2200000
0.5
1100000
Downward revision
285000
0.5
142500
Revised estimated annual cash flow after year 1
1242500
Figures in $
Year
Initial investment
Annual operating cash flow
Total cash flow
Disc Rate : 10%
Present value of cash flow
A
B
C
D
E
A+B
C*D
0
-7000000
0
-7000000
1
-7000000.00
1
0
1300000
1300000
0.909091
1181818.18
2
0
1242500
1242500
0.826446
1026859.50
3
0
1242500
1242500
0.751315
933508.64
4
0
1242500
1242500
0.683013
848644.22
5
0
1242500
1242500
0.620921
771494.74
6
0
1242500
1242500
0.564474
701358.86
7
0
1242500
1242500
0.513158
637598.96
8
0
1242500
1242500
0.466507
579635.42
9
0
1242500
1242500
0.424098
526941.29
10
0
1242500
1242500
0.385543
479037.54
Revised Net present value at year 0 (m)
686897.36
Future value factor for 1 year (n)
1.1
Revised Net present value at year 1 (m*n)
755587.09
Figures in $
Year
Initial investment
Annual operating cash flow
Total cash flow
Disc Rate : 10%
Present value of cash flow
A
B
C
D
E
A+B
C*D
0
-7000000
0
-7000000
1
-7000000.00
1
0
1300000
1300000
0.909091
1181818.18
2
0
1300000
1300000
0.826446
1074380.17
3
0
1300000
1300000
0.751315
976709.24
4
0
1300000
1300000
0.683013
887917.49
5
0
1300000
1300000
0.620921
807197.72
6
0
1300000
1300000
0.564474
733816.11
7
0
1300000
1300000
0.513158
667105.55
8
0
1300000
1300000
0.466507
606459.59
9
0
1300000
1300000
0.424098
551326.90
10
0
1300000
1300000
0.385543
501206.28
Net present value of New Video game
987937.24
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