Question

Rich Products is considering launching a new color printer that is designed to provide a better way to print color photos. They are forecasting increasing sales for the first three years, but then a decrease in year four as competitors arrive on the scene.

Year	Unit Sales
1	12,000
2	14,000
3	16,000
4	15,000

They plan to sell the units for $26.50 in years 1-2, $27.50 in year 3, but only $23.00 in year 4 when competitors begin to put downward pressure on the price. The cost to produce the devices is $13.50 per unit, while their fixed costs are $26,000 per year. The marketing department believes the printer will actually provide some competition to the other company producing printers, cutting into sales of their current products at a level of $2000 per year. They estimate that the project will require an initial increase in current assets of $10,000, and an increase in current liabilities of $6000. They assume full recovery of NOWC at the end of the project. The cost of the assembly equipment will be $300,000, with additional shipping costs of $4000, and installation costs of $20,000. The equipment is classified as 3-year rate (year one: 33%, year two: 45%, year three: 15%, year four:7%) . The operations manager believes the equipment can be salvaged at the end of the project for $84,000. The marginal tax rate is 34% and the required return on the project is 24%.

1) What is the NPV of the project?

2) Going back to the original project description and estimates, suppose the production manager comes back with a revised estimate of how much it will cost to produce the printer. She indicates a projected shortage of raw materials could push the cost to produce the devices to $15.50 per unit. What happens to the NPV?

Answer 1

Based on the given data, pls find below workings, steps and answers:

For Terminal Value, the discounted factor is applied for Year 5: The reason is that the actual cash flows are realised only after the end of the Year 4; Technically, the same (Working Capital, sale of asset, etc) cannot be pulled during Year 4 and at end of Year 4; hence, for Capital Budgeting techniques, these are considered as Terminal Cash Flows and the discount rate of next year to to life of Project is applied;

NPV of the project is $ 16503.32 and is recommended for investment.

If the cost of production is $ 15.50 / per unit; Then, the NPV of the project is - $ 34445.14 and the investment is not feasible.

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;