Question

A producer of electronic clocks, ClockRUs (CRU) wants to create an advertising campaign to stimulate their demand. Based on CRU?s experience, if they spend $250,000 on newspaper and magazines now, their sales should increase by $180,000 in the first year, and $150,000 in the second year. However, with the changing interest rate, and profitability concern, CRU must have 9% rate of return.

A) What is the Present Value of year 1 sales increase (cash flow in year 1)? (2 points)

B) What is the Present Value of year 2 sales increase (cash flow in year 2)? (2 points)

C) What is the cash flow now (what is CF(0))? (1 points)

D) Based on the NPV analysis, would you advise CRU to do the advertising? Explain why. (5 points)"

Answer 1

Solution :

A) The Present Value of year 1 sales increase (cash flow in year 1) = $ 165,137.6147

= $ 165,137.61 ( when rounded off to two decimal places )

B) The Present Value of year 2 sales increase (cash flow in year 2) = $ 126,251.9990

= $ 126,252.00 ( when rounded off to two decimal places )

C) The cash flow now ( at CF(0)) is the cost for the advertising campaign = - $ 250,000

D)

As per the NPV Rule or Criteria for evaluating a project’s acceptability

1.If the NPV of the project is Positive i.e., greater than zero, the Project should be accepted. A positive NPV implies the project has recovered its Initial Investment value.

2.If the NPV of the project is Negative i.e., less than zero, the Project should be rejected. A negative NPV implies the project has not been able to recover its Initial Investment value.

Based on the NPV analysis, CRU should do the advertising as the Net present value of the advertising campaign is positive at $ 41,389.61

= $ 41,389 ( when rounded off to the nearest dollar )

This implies that the increased sales has recovered the cost of the advertising campaign and CRU has earned $ 41,389 over and above the cost incurred.

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.