Question

You and your lifelong friend are partners together in the promotional materials business. That is, when marketing firms and their clients begin advertising or public relations campaigns, they come to your company to obtain the materials and products that would support the ad campaign. Examples of the materials and products you supply are printed posters, signs, T-shirts with printed logos, key chains, and other such items. You supply these items by procuring them from other sources or in some cases you manufacture them using various equipment in a warehouse you use near the center of the city. Your company’s name is WePROMOTE.

You and your business partner are planning the next major project for your company. The project is a significant step in the growth of your firm in that the project will generate cash inflows into the firm for many years into the future. However, there will be a large investment of funds required by the firm to launch the project. The planning is in its preliminary stages where the numbers and other data are gross estimates. Despite the “fuzzy numbers”, you and your partner still need to decide whether the project will be worth pursuing.

The following is some of the estimated data you have:

• The cost to install the required equipment will be $75,000 and this cost is incurred prior to any cash is received by the project.
  
  
• The expected cash inflows are the most variable of the estimates. Your partner is convinced that the firm will receive $15,000 annually for 7 years. You have your doubts. You think it is more reasonable that there will be cash inflows of $14,000 in years 1-2, then inflows of $15,000 from years 3-4, and then inflows of$17,000 for years 5-7.
  
  
• You both agree that after 7 years, the equipment will stop working and can be sold for its parts for about $5,000.
  
  
• Although you are hesitant to assume a 6% discount rate on this project (not much left for the firm after paying the interest on the loan) your partner is confident that this project will lead to other deals in the future that will bring in much more profit.

You trust your partner’s instincts and agree to start analyzing the feasibility of the project. The first step is to perform net present value (NPV) calculations for the project using your partner’s estimates and then using your estimates.

Requirements of the paper:

• Perform the two NPV calculations and provide a narrative of how you calculated both computations and why.
  
  
• Then provide a summary conclusion on whether you should continue to pursue this business opportunity.
  
  
• Finally, assuming your partner remains unconvinced of your conclusion, present relevant points of your analysis that you believe are compelling and persuasive in supporting your position.

Papers will be assessed using the following criteria:

• Accurate NPV calculations are provided
• Narrative that fully explains how NPVs were calculated and why is included
• A clear, logical summary and conclusion is given

Answer 1

Analysis 1 - When there is same cash flows over the years

Calculation of Net Present Value-

Calculation of Present Value of Net Cash Inflows-

Year	Cash Inflow	Sale of equipment	Net cash flow	PV Factor @6%	PV of Net Cash Inflow
1	15000	0	15000	0.943396226	14150.94
2	15000	0	15000	0.88999644	13349.95
3	15000	0	15000	0.839619283	12594.29
4	15000	0	15000	0.792093663	11881.40
5	15000	0	15000	0.747258173	11208.87
6	15000	0	15000	0.70496054	10574.41
7	15000	5000	20000	0.665057114	13301.14
PV of Total Net Cash Flow					87061.01

Present Value of Cash Outflow = $75,000

NPV = Present Value of Net Cash Inflows - Present Value of Cash Outflow

= $87,061.01 - $75,000 = $12,061.01

Analysis 2 - When there is different cash flows over the years

Calculation of Net Present Value-

Calculation of Present Value of Net Cash Inflows-

Year	Cash Inflow	Sale of equipment	Net cash flow	PV Factor @6%	PV of Net Cash Inflow
1	14000	0	14000	0.943396226	13207.55
2	14000	0	14000	0.88999644	12459.95
3	15000	0	15000	0.839619283	12594.29
4	15000	0	15000	0.792093663	11881.40
5	17000	0	17000	0.747258173	12703.39
6	17000	0	17000	0.70496054	11984.33
7	17000	5000	22000	0.665057114	14631.26
PV of Total Net Cash Flow					89462.17

Present Value of Cash Outflow = $75,000

NPV = Present Value of Net Cash Inflows - Present Value of Cash Outflow

= $89,462.17 - $75,000 = $14,462.17

Notes-

1. It is assumed that Tax is not applicable on the firm.

2. As there is no tax on the firm, therefore depreciation is not considered in calculation of Net cash flows.

3. NPV is calculated because we want to know the present value of net cash flows of the estimates we are making.

Conclusion - From the above analysis it can be seen that estimating the different cash flows over the period is better tan estimating the equal cash flows over the period, as in analysis 2 (where cash flows are different) NPV is more than in analysis 1 by $2401.16 (14462.17-12061.01)