Question

M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video game that requires an initial investment of $7.1 million. The company expects a total annual operating cash flow of $1.31 million for the next 10 years. The relevant discount rate is 11 percent. Cash flows occur at year-end.

a.	What is the NPV of the new video game? (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.

After one year, the estimate of remaining annual cash flows will be revised either upward to $2.21 million or downward to $286,000. Each revision has an equal probability of occurring. At that time, the video game project can be sold for $2.61 million. What is the revised NPV given that the firm can abandon the project after one year? (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). Solution :- Net present value (NPV) = Present value of cash inflows - Present value of cash outflow.

Present value of cash inflows = 1.31 Million * Cumulative present value factors for 10 years at 11 %(Note 1).

= 1.31 Million * 5.889 (approx)

= $ 7.71459 Million.

Present value of cash outflow = 7.10 Million (Given in the question)

Accordingly, Net present value (NPV) of new video game = 7.71459 Million - 7.10 Million

= $ 0.61459 Million i.e., $ 614590. (1 Million = 1000000, Thus, 0.61459 Million = 0.61459 * 1000000 = $ 6,14,590).

Conclusion :- NPV of new video game = $ 614590.00 (approx).

Note 1 :- Calculation of Cumulative present value factors for 10 years at 11 % :-

Cumulative present value factors for 10 years at 11 %. = [ 1 - (1 + Discount rate)-Time period in years] / Discount rate

= [ 1 - (1 + 0.11)-10 ] / 0.11

= [ 1 - (1.11)-10 ] / 0.11

= (1 - 0.3522) / 0.11

= 0.6478 / 0.11

= 5.889 (approx).