Question

X Company is planning to launch a new product. A market research study, costing $150,000, was conducted last year, indicating that the product will be successful for the next four years. Profits from sales of the product are expected to be $151,000 in each of the first two years and $107,000 in each of the last two years. The company plans to undertake an immediate advertising campaign that will cost $78,000. New manufacturing equipment will have to be purchased for $310,000; it will have zero disposal value at the end of the four years. Assuming a discount rate of 7%, what is the net present value of launching the new product?

Answer 1

Answer)

Calculation of Net Present Value

Net Present Value = Present Value of cash inflow – Present value of cash outflow

                                   = $ 441,984.40 – [($ 78,000 X 1) + ($ 310,000 X 1)]

                                  = $ 441,984.40 – [$ 78,000 + $ 310,000]

                                  =$ 441,984.40 - $ 388,000

                                  = $ 53,984.40

Therefore, the Net Present Value of launching the new product is $ 53,984.40 or $ 53,984 (rounded off).

Working Notes:

1.

Year end	Cash Inflow (Profits)	Present Value Factor (@ 7%)	Present Value
1	$ 151,000	0.93458	$ 141,121.50
2	$ 151,000	0.87344	$ 131,889.25
3	$ 107,000	0.81630	$ 87,343.87
4	$ 107,000	0.76290	$ 81,629.79
Total			$ 441,984.40

Note: Present value of cash inflow is the cash inflows from the launch of new products discounted at 7%.

2. Present value of cash outflow: The present value of cash outflow is the aggregate present value of all cash outflows discounted at appropriate rate of interest. Since in the given question, cash outflows are required to made at Zero period (i.e. today), the applicable discounting factor will be “1”.

3. Market research survey cost $ 150,000, is not considered while making the above decision, as it is a Sunk cost being historical (past) cost.