Payne Medical Labs is evaluating two new products to introduce into the marketpl

Question

Payne Medical Labs is evaluating two new products to introduce into the marketplace. Product 1 (a new form of plaster cast) is relatively low in risk for this business and will carry a 10 percent discount rate. Product 2 (a knee joint support brace) has a less predictable outcome and will require a higher discount rate of 15 percent. Either investment will require an initial capital outlay of 90,000. The inflows from projected business over the next 5 years are given below. Which product should be selected, using net present value analysis? Product 1 Product 2 Year 1 $25,000 $16,000 Year 2 30,000 22,000 Year 3 38,000 34,000 Year 4 31,000 29,000 Year 5 19,000 70,000

Explanation / Answer

net present value of product 1=

-90,000+(25000/1.1)+(30000/1.1^2)+(38000/1.1^3)+(31000/1.1^4)+(19000/1.1^5)= $ 19041.546

net present value of product 2=

-90,000+(16000/1.15)+(22000/1.15^2)+(34000/1.15^3)+(29000/1.15^4)+(70000/1.15^5)= $14286.972

Since the NPV of Product 2 is more, It should be selected.

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