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: $720,000 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.

$_____?_____ not 497959

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	-820000	-820000
1-4	148000	________? ________not 490191
5	348000	_________? ________not 236849
net present value		$_______?_______not -92960

Year Cash Flow Present Value 0 $__________ $__________ 1-4 $___________ $__________ 5 $___________ $__________ Net present value_________________________$___________

Answer 1

1-	Year	0	1	2	3	4	5
	cost of machine	-720000
	investment in working capital	-100000
	expected annual revenue		740000	740000	740000	740000	740000
	less operating expense		444000	444000	444000	444000	444000
	operating profit		296000	296000	296000	296000	296000
	recovery of working capital						100000
	scrap value of equipment						100000
	net operating cash flow	-820000	296000	296000	296000	296000	496000
	present value of cash flow at 8% = cash flow/(1+r)^n r= 8%	-820000	253772.3	253772.3	234974.3	217568.8	337569.3
2-	NPV = sum of present value of cash flow	477657
3-	Year	0	1	2	3	4	5
	cost of machine	-720000
	investment in working capital	-100000
	expected annual revenue		592000	592000	592000	592000	592000
	less operating expense		444000	444000	444000	444000	444000
	operating profit		148000	148000	148000	148000	148000
	recovery of working capital						100000
	scrap value of equipment						100000
	net operating cash flow	-820000	148000	148000	148000	148000	348000
	present value of cash flow at 8% = cash flow/(1+r)^n r= 8%	-820000	126886.1	126886.1	117487.2	108784.4	236843
	NPV = sum of present value of cash flow	-103113