Question

Bulldog Memorabilia, a small screen printing firm, is considering investing in new technology that allows customers to design their own products online, then they are automatically printed and shipped with only minimal labor costs. The firm has projected the following cash flows:

Time 0                   Time 1             Time 2             Time 3             Time 4             Time 5

-2,000,000             450,000            550,000            625,000            600,000            400,000

The firm anticipates selling the equipment for 300,000 (its salvage value) at time 5 and estimates the project cost of capital to be 10%. The firm estimates the IRR on the project to be 13.19%

The CFO of Bulldog is not sure that she is accurate in her estimates of the future cash flows and decides to conduct a scenario analysis. She has asked you to recalculate the NPV assuming that each cash flow and the salvage value are 10% higher than her initial estimate or 10 % lower. How is the estimate of NPV changed in each case (case1—all cash flows and the salvage value increase by 10%, case 2 all cash flows and the salvage value decrease by 10%)? Does the range of outcomes change how you would view the project? (10 points)

Answer 1

Base case :

Total cash inflow in Time 5 = cash flow + salvage value = 400,000 + 300,000 = 700,000

NPV is calculated using NPV function in Excel using 10% discount rate, which is the cost of capital for the firm

NPV is $177,661

If cash flows and salvage value are 10% higher :

NPV is $395,427

If cash flows and salvage value are 10% lower :

NPV is -$207,754

The range of values does affect how we view the project. If in the worst case, the cash flows and salvage value are 10% lower, the NPV becomes negative. As there is a fair chance of this actually happening, the project needs to be reconsidered