Question

Problem 7-24 Expansion Decisions

Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 14 units per year at $299,000 net cash flow per unit for the next five years. The engineering department has come up with the estimate that developing the machine will take a $14.1 million initial investment. The finance department has estimated that a discount rate of 15 percent should be used.

a.	What is the base-case NPV? (A negative answer should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Base-case NPV

$

b.

If unsuccessful, after the first year the project can be dismantled and will have an aftertax salvage value of $10.4 million. Also, after the first year, expected cash flows will be revised up to 19 units per year or to 0 units, with equal probability. What is the revised NPV? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Revised NPV

$

Answer 1

So we calculate the NPV for the base case first as shown in the table below:

Year	CF	Discount Factor		Discounted CF
0	$-14100000	1/(1+0.15)^0=	1	1*-14100000=	$   -141,00,000.00
1	$   41,86,000.00	1/(1+0.15)^1=	0.869565217	0.869565217391304*4186000=	$       36,40,000.00
2	$   41,86,000.00	1/(1+0.15)^2=	0.756143667	0.756143667296787*4186000=	$       31,65,217.39
3	$   41,86,000.00	1/(1+0.15)^3=	0.657516232	0.657516232431988*4186000=	$       27,52,362.95
4	$   41,86,000.00	1/(1+0.15)^4=	0.571753246	0.571753245593033*4186000=	$       23,93,359.09
5	$   41,86,000.00	1/(1+0.15)^5=	0.497176735	0.49717673529829*4186000=	$       20,81,181.81
				NPV = Sum of all Discounted CF	$            -67,878.76

• NPV = =$67,878.76
• As the base case NPV is negative and therefore the project should not be invested in

If unsuccessful, then the NPV would be as follows:

Year	CF	Discount Factor		Discounted CF
0	$   -141,00,000.00	1/(1+0.15)^0=	1	1*-14100000=	$   -141,00,000.00
1	$       41,86,000.00	1/(1+0.15)^1=	0.869565217	0.869565217391304*4186000=	$       36,40,000.00
1	$     104,00,000.00	1/(1+0.15)^1=	0.869565217	0.869565217391304*10400000=	$       90,43,478.26
				NPV = Sum of all Discounted CF	$      -14,16,521.74

If successful, then the NPV would be as follows:

Year	CF	Discount Factor		Discounted CF
0	$   -141,00,000.00	1/(1+0.15)^0=	1	1*-14100000=	$   -141,00,000.00
1	$       56,81,000.00	1/(1+0.15)^1=	0.869565217	0.869565217391304*5681000=	$       49,40,000.00
2	$       56,81,000.00	1/(1+0.15)^2=	0.756143667	0.756143667296787*5681000=	$       42,95,652.17
3	$       56,81,000.00	1/(1+0.15)^3=	0.657516232	0.657516232431988*5681000=	$       37,35,349.72
4	$       56,81,000.00	1/(1+0.15)^4=	0.571753246	0.571753245593033*5681000=	$       32,48,130.19
5	$       56,81,000.00	1/(1+0.15)^5=	0.497176735	0.49717673529829*5681000=	$       28,24,461.03
				NPV = Sum of all Discounted CF	$       49,43,593.11

Now the probability of success and failure is 0.5 each, therefore, probability weighted NPV =  0.5 x (49,43,593.11-14,16,521.74) =  $17,63,535.69

In this case, as the probability weighted NPV is positive, we should invest in the project.