Question

Net Present Value

Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product:

• Expected annual revenues: $740,000
• Projected product life cycle: five years
• Equipment: $730,000 with a salvage value of $100,000 after five years
• Expected increase in working capital: $100,000 (recoverable at the end of five years)
• Annual cash operating expenses: estimated at $444,000
• Required rate of return: 8 percent

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Estimate the annual cash flows for the new product. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow
0	$
1–4	$
5	$

2. Using the estimated annual cash flows, calculate the NPV.
$

3. What if revenues were overestimated by $148,000? Redo the NPV analysis, correcting for this error. Assume the operating expenses remain the same. Enter cash outflows as negative amounts and cash inflows as positive amounts.

Year	Cash Flow	Present Value
0	$	$
1–4
5
Net present value

Answer 1

Investment in Year-0
Investment in Equipment	-730000
Investment in WC		-100000
Investment in Year-0		-830000
Annual cash inflows:
Annual revenues expected	740000
Less: Annual operating cost	444000
Annual cash inflows:		296000
Cash flows at Year-5
Salvage value of equipment	100000
Release of Working capital	100000
Cash flows at Year-5		200000
Req 1.
Year	Cashflows
0Yr	-830000
1-4 yrs	296000
5 yr	496000
Req 2.
Year	Cashflows	PVF at 8%	Present values
0Yr	-830000	1	-830000
1-4 yrs	296000	3.31213	980390.5
5 yr	496000	0.680583	337569.2
NPV			487960
Req 3.
Annual cash inflows:
Annual revenues expected	592000	(740000-148000)
Less: Annual operating cost	444000
Annual cash inflows:		148000
Year	Cashflows	PVF at 8%	Present values
0Yr	-830000	1	-830000
1-4 yrs	148000	3.31213	490195.2
5 yr	348000	0.680583	236842.9
NPV			-102962