Question

You are CEO of Rivet​ Networks, maker of​ ultra-high performance network cards for gaming​ computers, and you are considering whether to launch a new product. The​ product, the Killer​ X3000, will cost $902,000 to develop up front​ (year 0), and you expect revenues the first year of $806,000​, growing to $1.57 . million the second​ year, and then declining by 45% per year for the next 3 years before the product is fully obsolete. In years 1 through​ 5, you will have fixed costs associated with the product of $90,000 per​ year, and variable costs equal to 50% of revenues.   

a. What are the cash flows for the project in years 0 through​ 5?

b. Plot the NPV profile for this investment using discount rates from​ 0% to​ 40% in​ 10% increments.

c. What is the​ project's NPV if the​ project's cost of capital is %9%​?

d. Use the NPV profile to estimate the cost of capital at which the project would become​ unprofitable; that​ is, estimate the​ project's IRR.

a. What are the cash flows for the project in years 0 through​ 5?

Calculate the cash flows​ below:  ​(Round to the nearest​ dollar.)

	0	1
Revenues	$0	$806,000
YOY growth
Variable costs
% of sales		50%
Fixed costs
Investment	(902,000)
Total cash flows	(902,000)

Answer 1

a. What are the cash flows for the project in years 0 through​5?
	0	1	2	3	4	5
Revenues	$                               -	$        806,000	$        1,570,000	$        863,500	$        474,925	$   261,209
YOY growth			95%	-45%	-45%	-45%
Variable costs		$     (403,000)	$         (785,000)	$     (431,750)	$     (237,463)	$ (130,604)
% of sales		50%	50%	50%	50%	50%
Fixed costs		$        (90,000)	$            (90,000)	$        (90,000)	$        (90,000)	$   (90,000)
Investment	$                 (902,000)
Total cash flows	$                 (902,000)	$        313,000	$            695,000	$        341,750	$        147,463	$     40,604
b. Plot the NPV profile for this investment using discount rates from​ 0% to​ 40% in​ 10% increments.
Excel formula to calculate NPV = NPV(Discount Rate , range of total cash flows starting from -902000 to 40604)
	Discount Rate	NPV
	0%	635,816.88
	10.0%	308,744.04
	20.0%	105,563.71
	27.5%	2,944.07
	37.5%	(91,478.05)
c. What is the​ project's NPV if the​ project's cost of capital is %9%​?
	Discount Rate	NPV
	9%	334,746.31
d. Use the NPV profile to estimate the cost of capital at which the project would become​ unprofitable; that​ is, estimate the​project's IRR.
	Discount Rate	NPV
	25%	33,505.51
	28%	(2,784.24)
at approx 28%, the project will be unprofitable