Question

You are CEO of Rivet​ Networks, maker of​ ultra-high performance network cards for gaming​ computers, and you are considering whether to launch a new product. The​ product, the Killer​ X3000, will cost $ 904 comma 000 to develop up front​ (year 0), and you expect revenues the first year of $ 797 comma 000​, growing to $ 1.42 million the second​ year, and then declining by 40 % per year for the next 3 years before the product is fully obsolete. In years 1 through​ 5, you will have fixed costs associated with the product of $ 91 comma 000 per​ year, and variable costs equal to 55 % of revenues.   

a. What are the cash flows for the project in years 0 through​ 5?

b. Plot the NPV profile for this investment using discount rates from​ 0% to​ 40% in​ 10% increments.

c. What is the​ project's NPV if the​ project's cost of capital is 10.3 %​?

d. Use the NPV profile to estimate the cost of capital at which the project would become​ unprofitable; that​ is, estimate the​ project's IRR.

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial outflow	-904000	0	0	0	0	0
Revenue	0	797000	1420000	852000	511200	306720
Fixed Cost	0	-91000	-91000	-91000	-91000	-91000
Variable Cost	0	-438350	-781000	-468600	-281160	-168696
Cashflow	-904000	267650	548000	292400	139040	47024

		10%		20%		30%		40%		10.30%
Year	Cash flow project A	PVF 10%	PV CF	PVF 20%	PV CF	PVF 30%	PV CF	PVF 40%	PV CF	PVF 10.3%	PV CF
Year 0	-904000.00	1.000	-904000.00	1.000	-904000.00	1.000	-904000.00	1.000	-904000.00	1.000	-904000.00
Year 1	267650.00	0.909	243318.18	0.833	223041.67	0.769	205884.62	0.714	191178.57	0.907	242656.39
Year 2	548000.00	0.826	452892.56	0.694	380555.56	0.592	324260.36	0.510	279591.84	0.822	450432.31
Year 3	292400.00	0.751	219684.45	0.579	169212.96	0.455	133090.58	0.364	106559.77	0.745	217896.79
Year 4	139040.00	0.683	94966.19	0.482	67052.47	0.350	48681.77	0.260	36193.25	0.676	93937.22
Year 5	47024.00	0.621	29198.20	0.402	18897.89	0.269	12664.93	0.186	8743.38	0.613	28803.28
		NPV 10%	136059.59	NPV 20%	-45239.45	NPV 30%	-179417.75	NPV 40%	-281733.19	NPV 10.3%	129725.99
Interpolation formula		lower rate + difference in rate [lower rate NPV/(lower rate NPV-higher rate NPV)]
IRR		17.20

200000 150000 100000 50000 0 -50000 -100000 -150000 -200000 -250000 -300000 -350000 1 Rate NPV

Rate	10%	20%	30%	40%
NPV	136059.59	-45239.45	-179417.75	-281733.19