Question

9. value: 1.00 points Allied Products, Inc., is considering flow of $9.1 million for the next 9 years. Allied Products uses a discount rate of 14 percent for new product launches. The initial investment is $39.1 million. Assume that the project has no salvage value at the end of its economic life. product launch. The firm expects to have annual operating cash a new a. What is the NPV of the new product? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to 2 decimal places, e.g. 32.16.) NPV 5911983.71 b. After the first year, the project can be dismantled and sold for $26.1 million. If the estimates of remaining cash flows are revised based on the first year's experience, at what level of expected cash flows does it make sense to abandon the project? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Round your answer to 2 decimal places, e.g. 32.16.) Annual cash flows

Answer 1

Ans a.

We should first calculate the present value of all the future cash flow. Below formula can be used in this case since the cash flow are equal and occur at same time.

2nd step would be to subtract the same (step one value) from initial investment.

CL Co NPV =+r

A P C D E F 1 Year Cost (Outflow) Cash Inflow PV value of cash flow at year 0 NPV (D2-B2) in Million $ NPV (D2-B2) in $ 45.01 2 C 39.1 0 5.91 59,11,983.71 2 1 9.1 7.98 4 2 9.1 7.00 5 9.1 6.14 6 4 9.1 5.39 7 9.1 4.73 8 6 9.1 4.15 9 7 9.1 3.64 10 9.1 3.19 11 9.1 2.80 12 14% 13 Discount rate 14 LC

Ans b.

Since at the end of 1st year decision will be taken. This can be dismantle @ $26.1 mn depending on cash flow.

So first we will calculate the present value at the end of year 1. If the PV of cash flows exceeds the value of dismantling project, we should not dismantle.

Now, understand the correct level of cash flow, we can use the hit and trial method until the cash flows present value is same as disposal profit.

A P D E Year Cost (Outflow) Cash Inflow PV value of cash flow at year 0 1 2 C 26.1 0 26.10 0.00 3 1 5.626 4.94 4 2 5.626 4.33 5 3 5.626 3.80 4 5.626 3.33 7 5.626 2.92 8 6 5.626 2.56 9 7 5.626 2.25 10 8 5.626 1.97 11 5.626 1,73 12

So, if cash flow goes down beyond $5.63 Mn, the dismantling value would be a better option rather than contuning with existing set-up.