Question

Holland Inc. has just completed development of a new cell phone. The new product is expected to produce annual revenues of $1,350,000. Producing the cell phone requires an investment in new equipment, costing $1,440,000. The cell phone has a projected life cycle of 5 years. After 5 years, the equipment can be sold for $180,000. Working capital is also expected to increase by $180,000, which Holland will recover by the end of the new product’s life cycle. Annual cash operating expenses are estimated at $810,000. The required rate of return is 8%.

1. Prepare a schedule of the projected annual cash flows.

2. Calculate the NPV using only discount factors listed below:

Discount Factor

Year 0    1.00000

Year 1    0.92593

Year 2    0.85734

Year 3    0.79383

Year 4    0.73503

Year 5    0.68058

3. Calculate the NPV using discount factors listed below:

Discount Factor

Year 0    1.00000

Year 1-4 3.31213

Year 5    0.68058

Answer 1

Cash flows for Year-0
Investment of Equipment cost		-14,40,000
Investment in Working capital		-1,80,000
Cash flows for Year-0			-16,20,000
Annual cash flows (From Year 1 to 4)
Annual revenue			13,50,000
Less: Annual operating cost		8,10,000
Annual cash flows:			5,40,000
Cash flows of Year-5
Annual cash flows			5,40,000
Release of working capital		1,80,000
Salvage value of equipment		1,80,000
Cash flows of Year-5			9,00,000
Year	Cashflows
0	-16,20,000
1	5,40,000
2	5,40,000
3	5,40,000
4	5,40,000
5	9,00,000
Req 2.
NPV
Year	Cashflows	Discount Factor	Present value
0	-16,20,000	1		-1620000
1	5,40,000	0.92593		500002.2
2	5,40,000	0.85734		462963.6
3	5,40,000	0.79383		428668.2
4	5,40,000	0.73503		396916.2
5	9,00,000	0.68058		612522
NPV				7,81,072
Req 3.
NPV
Year	Cashflows	Discount	Present value
0	-16,20,000	1	-1620000
1--4	5,40,000	3.31213	1788550
YEar5	9,00,000	0.68058	612522
NPV			781072