Question

Suppose that a company is evaluating a project to launch a new product. It estimates that if it launches the new product:

i) The sales of some other products will decline

ii) The interest expense of the company will go up

iii) The firm pays higher dividends by retaining less earnings

iv) The inventory will go up at the beginning of the project and then decline towards the end of the project

Which of the above should the company take into account when calculating the project's NPV?

Answer 1

iv) The inventory will go up at the beginning of the project and then decline towards the end of the project

In NPV analysis of a project, only after tax cash flow from project is considered to compute NPV of project. An increase in inventory reduce the cash flow of project thus, change in inventory should be taken into account while calculating the project's NPV.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.