Question

X Company is planning to launch a new product. A market research study, costing $100,000, 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 $163,000 in each of the first two years and $103,000 in each of the last two years. The company plans to undertake an immediate advertising campaign that will cost $90,000. New manufacturing equipment will have to be purchased for $330,000; it will have zero disposal value at the end of the four years. Assuming a discount rate of 6%, what is the net present value of launching the new product?

Answer 1

We have to calculate Net Present Value (NPV) of the product, for this we have to identify the inflow and outflow of the product and calculate their NPV

The below mentioned outflow related to product are:

1. Market Research Study - $1,00,000

2. Advertising Campaign - $ 90,000

3. Manufacturing Equipment - $ 3,30,000

Present Value of the above outflows are :

1. Market Research Study Conducted last year so we have to calculate its Present Value i.e. $1,00,000 * 1.06 = $1,06,000

2. Advertising Campaign required immediate implementation so the present value will be same as actual cost i.e. $ 90,000

3. Manufacturing Equipment has to be purchased now so the cost of the equipment will be the present value i.e. $ 3,30,000 because it has no disposal value after 4 years.

So Present Value of total out flows are 106000+90000+330000 = $ 5,26,000

Now we have to calculate present value of Inflows that are as under:

Profit from the sales of the product are expected to be $ 163000 in first two years and $ 103000 in last two years so the discounting cash inflows are calculated as follows:(Assuming the profits stated are profit after tax so we have to add back Depreciation to the profit because of Non Cash expenditure and Deprecation is calculated on straight line method i.e. 330000/4 = $82,500 Per Year)

Hence the cash inflow will be increased by $82,500 per year

YEAR CASH INFLOW DISCOUNTING FACTOR    PRESENT VALUE

1 245500    1/1.06 = 0.9434    231605

2 245500 1/(1.06*1.06) = 0.890    218495

3 185500 1/(1.06*1.06*1.06)=0.8396 155746

4 185500    1/(1.06*1.06*1.06*1.06)=0.7921    146935

Total Present Value for 4 years is $ 7,52,781

So the NPV of the product is Present Value of cash inflow - Present Value of cash outflow

$7,52,781 - $5,26,000 = $2,26,781

Note; Figures are rounded off to nearest $ whenever required.