Question

Family Life Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follows:

 

 

Each product requires an investment of $440,000. A rate of 15% has been selected for the net present value analysis.

Instructions
1. Compute the following for each project:
a. Cash payback period.
b. The net present value
. Use the present value of $1 table appearing in this chapter.
2. Prepare a brief report advising management on the relative merits of each of the twoproducts.

Answer 1

1. a.   Cash payback period for both products: 2 years (the year in which accumulated net cash flows equal $440,000), shown as follows:

 

   Home & Garden   Today's Teen  

   Net Cash   Cumulative Net Cash   Cumulative

   Year   Flow    Net Cash Flow    Year    Flow Net Cash Flow

 

   1   $230,000 $  230,000 1   $160,000 $160,000

   2 210,000    440,000 2 280,000    440,000

 

 

b.   Net present value analysis:

  Present Value of

Present   Net Cash Flow        Net Cash Flow

Value of    Home & Today's    Home & Today's

   Year   $1 at 15%    Garden Teen    Garden    Teen

 

   1   0.870   $230,000 $160,000    $200,100 $139,200

   2   0.756 210,000   280,000   158,760    211,680

   3   0.658 190,000   200,000   125,020    131,600

   4   0.572    50,000 40,000 28,600 22,880

   5   0.497   40,000     40,000   19,880     19,880

   Total................................. $720,000 $720,000    $532,360 $525,240

   Amount to be invested......................................................... 440,000   440,000

   Net present value.................................................................. $ 92,360   $ 85,240

 

2. The report can take many forms and should include, as a minimum, the following points:

a.   Both products offer the same total net cash flow.

b.   Both products offer the same cash payback period.

c.   Because of the timing of the receipt of the net cash flows, the Home & Garden magazine offers a higher net present value.

d.  Both products provide a positive net present value. .

This means both products would be acceptable, since they exceed the minimum rate of return