Question

Net Present Value

Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product:

• Expected annual revenues: $720,000
• Projected product life cycle: five years
• Equipment: $740,000 with a salvage value of $100,000 after five years
• Expected increase in working capital: $120,000 (recoverable at the end of five years)
• Annual cash operating expenses: estimated at $432,000
• Required rate of return: 8 percent

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Estimate the annual cash flows for the new product. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow
0	$
1–4	$
5	$

2. Using the estimated annual cash flows, calculate the NPV.
$

3. What if revenues were overestimated by $144,000? Redo the NPV analysis, correcting for this error. Assume the operating expenses remain the same. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow	Present Value
0	$	$
1–4
5
Net present value		$

Answer 1

1.

Particulars	Year 0	Year 1-4	Year 5
Initial investment	(740,000)
Increase in WC	(120,000)
Expected annual revenues		720,000	720,000
Annual Expenses		(432,000)	(432,000)
Salvage value			100,000
Release of working capital			120,000
Expected Cash Flows	(860,000)	288,000	508,000

2.

Year	Cash Flow	PVF	Present values
Year 0	(860,000)	1	(860,000)
Year 1-4	288,000	3.312	953,856
Year 5	508,000	.681	345,948
Net Present Value			439,804

3.

Particulars	Year 0	Year 1-4	Year 5
Initial investment	(740,000)
Increase in WC	(120,000)
Expected annual revenues		576,000	576,000
Annual Expenses		(432,000)	(432,000)
Salvage value			100,000
Release of working capital			120,000
Expected Cash Flows	(860,000)	144,000	364,000

Year	Cash Flow	PVF	Present values
Year 0	(860,000)	1	(860,000)
Year 1-4	144,000	3.312	476,928
Year 5	364,000	.681	247,884
Net Present Value			(135,188)