Jason\'s company has a cost of capital of 8% and estimates it could sell 10,000
ID: 2658064 • Letter: J
Question
Jason's company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The book would sell for $7.50 per copy and net the company a profit of $6 per copy after royalties, marketing costs and taxes. Year one net would be $60,000.
From a capital budgeting standpoint, is it financially wise to buy the publication rights? What is the NPV of this investment? The year 0 cash flow is -20,000, year 1 is 60,000, and years 2 and 3 are 30,000 each. Given a cost of capital of 8%, the NPV is just over $85,000. It looks good, right?
Explanation / Answer
Calculation of NPV of project (to buy publication rights) Year Cash flow Discount factor @ 8% Present Value 0 -$20,000.00 1 -$20,000.00 1 $60,000.00 0.925926 $55,555.56 2 $30,000.00 0.857339 $25,720.16 3 $30,000.00 0.793832 $23,814.97 NPV $85,090.69 As the NPV of the project is positive, it is financially wise to buy the publication rights.
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