Question

Digital Healthcare Co., a mid-size electronic medical device maker, has decided to downsize as a measure to reduce cost in response weak demand. The company is considering implementing one of two plans:

the first plan involves closing and selling a manufacturing plant in Maple Ridge, which is expected to generate a salvage value of $5 million today (year 0) and save $1.5 million annually in cost and expenses over the next 10 years (years 1 to 10). However, the company will lose $1 million in revenue the first year (year 1), and the loss will increase by 10% per year over the following 9 years (years 2 to 10).

NPV Plan A = $____ million

Answer 1

Net Present Value = PV of cash inflows- PV of cash outflows

Assuming Discounting Rate is 10%

Salvage value that can be earned Now (Year0)= $5 Million(Cash inflow) (A)

As $1.5 million is saved every year ,it is similar to cash inflow and Present cash flows of $1.5 million is to be calculated for 10 years @10% rate.

Discounting factor is calculated as follows: 1/(1+R)^n

Where R is Discounting rate, N is number of years for which it has to be discounted.

Discounting factors @10% rate for 10 years are as follows

Year	1	2	3	4	5	6	7	8	9	10
Discounting factor	0.909	0.826	0.751	0.683	0.621	0.564	0.513	0.467	0.424	0.386

  

Sum of discounting factors from 1 to 10 years is (0.909+0.826+....+0.386) =6.145

Therefore present value of $1.5 million saved annualy for 10 years is = $1.5 million * 6.145

=$9216850.65 (B)

Losses to be incurred by company for 10 years are as follows: $ in millions

Year	1	2	3	4	5	6	7	8	9	10
$ in milions	1	1.1	1.2	1.3	1.4	1.5	1.6	1.7	1.8	1.9

As loss increases every year by 10% , Loss is varying every year , this is similar to cash outflow.

Now, Calculate present value of above losses for 10 years

Year	1	2	3	4	5	6	7	8	9	10
Loss in $millions (a)	1	1.1	1.2	1.3	1.4	1.5	1.6	1.7	1.8	1.9
Disc. Factor@ 10% (b)	0.909	0.826	0.751	0.683	0.621	0.564	0.513	0.467	0.424	0.386
Present Value (a*b)	0.909	0.909	0.902	0.888	0.869	0.847	0.821	0.793	0.763	0.733

Sum of above present values (0.909+0.909+....+0.733)= $8.434 millions (C)

Therefore net present value is = (A) +(B) -(C)

=5000000+9216850.65-8434000

=$5783149

Answer 2

                 

• Plan A:

  NPV=5+1.50.12(1−11.1210)−10.12−0.1(1−(1.11.12)10)=$5.23 million

• Plan B:

  NPV=8−11.125⋅30.12(1−11.125)=$1.86 million

Plan A has a larger NPV.