Question

The marketing department is proposing to launch a new product; the Whiz Bang Flambo – WBF for short. They have conducted market research and are estimating sales of 50,000 per year if the price is set at $15. The development department has studied the specifications and is estimating it will take two years to bring the product to market and will cost $400,000 in the first year and $700,000 in the second year. The operations department is estimating it will cost five dollars to produce each WBF.

Calculate the net present value using a time horizon of five years (two years for development and three years of sales) and a discount rate of 20%. Recalculate using a discount rate of 10%.

Answer 1

Life of the investment = 5 years

First two years development cost = 1^st year = $400,000 & 2^nd year = $700,000

Sales for next three years = 50,000 per year at $15 = $750,000

Cost of production = $5 per product = Cost per year = 50,000*$5 = $250,000

Net Sales per year = $750,000 – $250,000 = $500,000

NPV at 20% = -$400,000 (P/F, 20%, 1) – $700,000 (P/F, 20%, 2) + $500,000 (P/A, 20%, 3) (P/F, 20%, 2)

NPV at 20% = -$400,000 (0.8333) – $700,000 (0.6944) + $500,000 (2.1065) (0.6944) = -88,023.2

NPV at 10% = -$400,000 (P/F, 10%, 1) – $700,000 (P/F, 10%, 2) + $500,000 (P/A, 10%, 3) (P/F, 10%, 2)

NPV at 10% = -$400,000 (0.9091) – $700,000 (0.8264) + $500,000 (2.4869) (0.8264) = 85,467.08