Question

We are examining a new project. We expect to sell 6,800 units per year at $62 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $62 × 6,800 = $421,600. The relevant discount rate is 16 percent and the initial investment required is $1,790,000.

   

a.	What is the base-case NPV? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b.

After the first year, the project can be dismantled and sold for $1,660,000. If expected sales are revised based on the first year’s performance, below what level of expected sales would it make sense to abandon the project? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1

To calculate NPV of the given case the discount rate is 16% which will be used to calculate the time value of money or the expected cashflow.

I have solved the given problem on excel sheet, kindly refer below to find the solution.

(b). It is given that after the first year project can be dismantled and can be sold for $1,660,000. Now we need to calculate the NPV of the project after 1 year and we have to check whether it is positive or negative at the given level of expected sales(6,800 units).

Therefore, Initial Investment = $1,790,000 = Cash outflow

Cash Inflow for year 1 = 6,800 * $62 = $421,600

Present value of Cash inflow = $421,600 * 1/(1+0.16)^1 = $363,448.2759

Cash Inflow due to dismantal of the project i,e., salvage value = $1,660,000

Present Value of Salvage Value = $1660,000 * 1/(1+0.16)^1 = $1,431,034.483

Total Present Value of Cash inflow = $363,448.2759 + $1,431,034.483 = $1,794,482.759

NPV of the Project = Present value of cash inflow - Initial Investment = $1,794,482.759 - $1,790,000 = $4482.760

The NPV for the given project at the end of the Year 1 is positive it means the given level of sales is relevant for the project to have positive NPV, hence below than that would make sense to abondon the project.