Question

Perot Corporation is developing a new CPU chip based on a new type of technology. Its new chip, the Patay2 chip, will take two years to develop. However, because other chip manufacturers will be able to copy the technology, it will have a market life of two years after it is introduced. Perot expects to be able to price the chip higher in the first year, and it anticipates a significant production cost reduction after the first year as well. The relevant information for developing and selling the Patay2 is given as follows:

PATAY2 CHIP PRODUCT ESTIMATES

Development cost $ 20,000,000

Pilot testing $ 5,000,000

Debug $ 3,200,000

Ramp-up cost $ 3,000,000

Advance marketing $ 5,400,000

Marketing and support cost $ 1,000,000 per year

Unit production cost year 1 $ 655.00

Unit production cost year 2 $ 545.00

Unit price year 1 $ 820.00

Unit price year 2 $ 650.00

Sales and production volume year 1 - 250,000

Sales and production volume year 2 - 150,000

Interest rate 10 % Assume all cash flows occur at the end of each period.

a. What is the net present value (at the discount rate of 10%) of this project? (Negative value should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your answer to the nearest thousand.)

b. Perot’s engineers have determined that spending $10 million more on development will allow them to add even more advanced features. Having a more advanced chip will allow them to price the chip $50 higher in both years ($870 for year 1 and $700 for year 2). What is the NPV of the project if this option is implemented? (Negative value should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your answer to the nearest thousand.)

c. If sales are only 200,000 the first year and 100,000 the second year, what would the NPV of the project be? Assume the development costs and sales price are as originally estimated. (Negative value should be indicated by a minus sign. Enter your answer in thousands of dollars. Round your answer to the nearest thousand.)

Answer 1

PATAY2 CHIP PRODUCT

a. Calculation of NPV:

Development cost $ 20,000,000

Pilot testing $ 5,000,000

Debug $ 3,200,000

Ramp-up cost $ 3,000,000

Advance marketing    $ 5,400,000

Cost at year zero $3,66,00,000

	Year1	Year2
Sale volume	250000	150000
Unit price	820	650
Unit Cost	(655)	(545)
Profit per unit	165	105
	*250000	*150000
Total Profit	$41250000	$15750000
Marketing support cost	(1000000)	(1000000)
Net inflow	$40250000	$14750000

PVF @ 10%

Year zero	3,66,00,000	1	-3,66,00,000
Year 1	40250000	0.909	36,58,7250
Year 2	14750000	0.826	12,18,3500

NPV= $12,171,000(rounding off to nearest thousands)

Project shows a positive NPV.

Part b. Total cost at year zero = 3,66,00,000 + 10,00,000

=$ 37,600,000

	Year1	Year2
Sale volume	250000	150000
Unit price	870	700
Unit Cost	-655	-545
Profit per unit	215	155
	*250000	*150000
Total Profit	$53750000	$23250000
Marketing support cost	-1000000	-1000000
Net inflow	$52750000	$22250000

PVF @ 10%

Year zero	37,600,000	1	-37,600,000
Year 1	52750000	0.909	47,949,750
Year 2	22250000	0.826	18,378,500

NPV= $28,728,000(rounding off to nearest thousands)

Project shows a positive NPV.

Part c. Total cost at year zero = 3,66,00,000

	Year1	Year2
Sale volume	200000	100000
Unit price	820	650
Unit Cost	-655	-545
Profit per unit	165	105
	*200000	*100000
Total Profit	$33000000	$10500000
Marketing support cost	-1000000	-1000000
Net inflow	$32000000	$9500000

PVF @ 10%

Year zero	37,600,000	1	-37,600,000
Year 1	32000000	0.909	29,088,000
Year 2	9500000	0.826	7,847,000

NPV= - $665,000(rounding off to nearest thousands)

Project shows a negative NPV.