3. A new product launch has the following cash flow attributes: Start-up cost at

Question

3. A new product launch has the following cash flow attributes: Start-up cost at the beginning of the launch (t-0): $2,000,000 Annual production costs: Annual revenue: Product Life Cycle: $100,000 per year $1,000,000 per year 5 years · . Using the interest tables and an effective annual interest rate of 8%, determine the following: 1) cash flow diagram, 2) present value of the costs, 3) present value of the revenue, and 4) Net Present Value of this transaction. If the goal of the company is a MARR of at least 12%, do you recommend manufacturing and selling this product? (20 pts) Extra Credit: Model the cash flows for problem #3 using the NPV template, and estimate the actual ROR using Excel. (20 pts)

Explanation / Answer

1-

Year

annual revenue

annual cost

annual cash flow

0

-2000000

1

1000000

100000

900000

2

1000000

100000

900000

3

1000000

100000

900000

4

1000000

100000

900000

5

1000000

100000

900000

2-

present value of cost

year

present value of cost = cost/(1+r)^n r= 8%

0

-2000000

-2000000

1

-100000

-92592.6

2

-100000

-85733.9

3

-100000

-79383.2

4

-100000

-73503

5

-100000

-68058.3

sum of present value of annual cost

-2399271

3-

present value of revenue

year

annual revenue

present value of annual revenue = annual revenue/(1+r)^n r= 8%

0

0

0

1

1000000

925925.9

2

1000000

857338.8

3

1000000

793832.2

4

1000000

735029.9

5

1000000

680583.2

sum of present value of annual revenue

3992710

4-

Net present value

sum of present value of annual revenue-sum of present value of cost

3992710-(-2399271)

1593439

5-

if MARR of 12%

present value of annual revenue = annual revenue*PVAF at 12% for 5 Years

1000000*.36047

3604770

less present value of annual cost

100000*3.60477

360477

less present value of initial investment

2000000

Net present value

1244293

PVAF at 12% for 5 Years

1-(1+r)^-n / r

1-(1.12)^-5 / .12

3.60477

Yes at 12% MARR project should be accepted as it results in Positive NPV

1-

Year

annual revenue

annual cost

annual cash flow

0

-2000000

1

1000000

100000

900000

2

1000000

100000

900000

3

1000000

100000

900000

4

1000000

100000

900000

5

1000000

100000

900000

2-

present value of cost

year

present value of cost = cost/(1+r)^n r= 8%

0

-2000000

-2000000

1

-100000

-92592.6

2

-100000

-85733.9

3

-100000

-79383.2

4

-100000

-73503

5

-100000

-68058.3

sum of present value of annual cost

-2399271

3-

present value of revenue

year

annual revenue

present value of annual revenue = annual revenue/(1+r)^n r= 8%

0

0

0

1

1000000

925925.9

2

1000000

857338.8

3

1000000

793832.2

4

1000000

735029.9

5

1000000

680583.2

sum of present value of annual revenue

3992710

4-

Net present value

sum of present value of annual revenue-sum of present value of cost

3992710-(-2399271)

1593439

5-

if MARR of 12%

present value of annual revenue = annual revenue*PVAF at 12% for 5 Years

1000000*.36047

3604770

less present value of annual cost

100000*3.60477

360477

less present value of initial investment

2000000

Net present value

1244293

PVAF at 12% for 5 Years

1-(1+r)^-n / r

1-(1.12)^-5 / .12

3.60477

Yes at 12% MARR project should be accepted as it results in Positive NPV

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