Question

Herjavec Enterprises is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that the company can sell 15 units per year at $308,000 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 $15.2 million initial investment. The finance department has estimated that a discount rate of 16 percent should be used.

a.	What is the base-case NPV? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

b.

If unsuccessful, after the first year, the project can be dismantled and will have an aftertax salvage value of $11.3 million. Also, after the first year expected cash flows will be revised up to 20 units per year or down to 0 units with equal probability. What is the revised NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

a.) Selling price per unit = $308,000

Selling price of 15 units = (308,000*15) = $4,620,000/year (assuming recieved at end of year)

Initial Investment = $15,200,000

NPV = PV of Inflows - PV of Outflows

= (4,620,000/1.16 + 4,620,000/1.16^2 +.........+4,620,000/1.16^5) - 15,200,000

= 15,127,236.679915 - 15,200,000

= - $72,763.32 (Answer)

b) For the revised NPV we will consider both cases seperately  

CASE 1 --> project dismantled

Cash inflow after 1 year = $11,300,000

NPV = 11,300,000/1.16 - 15,200,000

= 9,741,379.31 - 15,200,000

= - $5,458,620.69

CASE 2 --> producing 20 units per year after 1st year

Cash in flow from second year = 20*308,000 = $6,160,000 (assumed received at end of year)

NPV = (4,620,000/1.16+ 6,160,000/1.16^2 + 6,160,000/1.16^3+....+ 6,160,000/1.16^5) - 15,200,000

= (3,982,758.6207+14,859,304.0789-15,200,000)

= $3,642,062.70

E(NPV) =

= 3,642,062.70 * 0.5 - 5,458,620.69 * 0.5

= -$ 908,278.99 (Answer)