Question

X Company is planning to launch a new product. A market research study, costing $120,000, 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 $164,000 in each of the first two years and $101,000 in each of the last two years. The company plans to undertake an immediate advertising campaign that will cost $76,000. New manufacturing equipment will have to be purchased for $390,000; it will have zero disposal value at the end of the four years. Assuming a discount rate of 5%, what is the net present value of launching the new product?

Answer 1

The market research study cost of $120,000 has already been incurred. Hence, it is classified as sunk cost and is irrelevant for the decision making purpose.

Calculation of Net Present Value (NPV) of launching the new product:

Year	Particulars	Cashflow ($)	Discount Rate @ 5%	Discounted Cash flow ($)
0	Cost of equipment	-390,000	1	-390,000
0	Advertisement cost	-76,000	1	-76,000
1	Cash Inflow - Profits	164,000	0.9524	156,193.60
2	Cash Inflow - Profits	164,000	0.9070	148,748.00
3	Cash Inflow - Profits	101,000	0.8638	87,243.80
4	Cash Inflow - Profits	101,000	0.8227	83,092.70
		Net Present Value (NPV)		9,278.10

The Net Present Value (NPV) of launching the new product is $9,278.10. Since the NPV results in positive the product can be launched.