Question

X Company is planning to launch a new product. A market research study, costing $190,000, 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 $151,000 in each of the first two years and $117,000 in each of the last two years. The company plans to undertake an immediate advertising campaign that will cost $88,000. New manufacturing equipment will have to be purchased for $340,000; 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

Answer)

Calculation of Net Present Value of launching the new product

Net Present value = Present value of cash inflows – Present value of cash outflows

                                  =   $ 478,096 – [($ 88,000 X 1) + ($ 340,000 X 1)]

                                   = $ 478,096 - $ 428,000

                                   = $ 50,096      

Therefore the net present value of launching the new product is $ 50,096.

Working Notes:

1. Calculation of Present value of cash inflows:

Year End	Cash Inflows	Present value factor @5%	Present value
1	$ 151,000	0.95238	$ 143,810
2	$ 151,000	0.90703	$ 136,961
3	$ 117,000	0.86384	$ 101,069
4	$ 117,000	0.82270	$ 96256
Total			$ 478,096

Therefore the present value of cash inflows is $ 478,096.

2. Since payment for advertisement campaign (i.e. $ 88,000) and purchase of new equipment (i.e. $ 340,000) will be made today, the present value of factor while calculating the present value of cash outflows is taken to be “1”.
3. Cost of market research survey (i.e. $ 190,000) has not been considered in calculation of net present value it is a sunk cost (being past cost or historical cost).