Question

R&D Computer Inc. is debating on whether to develop a new anti-virus software. Development will take three years and the cost is $4000 per year. Once in production, the software will make $3000 per year for the next s seven years. The cash inflows begin at the end of year 4. Assuming the cost of capital is 10%

a. Calculate the NPV, should the company make this investment?

b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

Assuming the cost of capital is 15%

a. Calculate the NPV, should the company make this investment?

b. Calculate the IRR and determine how much the cost of capital estimate must deviate to change this decision?

Answer 1

Assuming that the first development cost is incurred at the end of year 1

Year	Cost of development	Cash inflows	Net Cash flows
1	-4000		-4000
2	-4000		-4000
3	-4000		-4000
4		3000	3000
5		3000	3000
6		3000	3000
7		3000	3000
8		3000	3000
9		3000	3000
10		3000	3000
		NPV	$1,025.74
		IRR	12.35%

a: NPV = $1025.74

b: IRR= 12.35%. The cost of capital can decrease by 2.65% to change this decision.

WORKINGS