Question

New Air Heating and Cooling, manufactures furnaces and central air units. The company pride itself on providing the most cost effective and affordable units in the Midwest. This year the company would like to create a new high efficiency furnace.   The research and engineering team have produced the following data. The production start-up, marketing, and production cost estimates are based on previous experience of producing similar products. The revenues are also based on previous experience; however, management understand that there will be an impact on the existing sales volume due to the economy and other current market issues. The estimated cash flows are below. Calculate the NPV assuming a cost of capital of 5% for the initial year and then for the next three years a cost of capital of 12%, and for all remaining years, a cost of capital of 18%.

Please provide your recommendation for this project based on the NPV of the project.

Cash flows in Thousands of Dollars

	Dev. Cost	Equip Cost	Market Cost	Prod.
Years				Sales
0	(500)	(75)
1		(70)	(30)	100
2			(30)	125
3			(30)	135
4			(50)	145
5			(50)	155
6			(60)	165
7		(25)	(60)	175
8		(25)	(60)	175
9		(25)	(60)	175

Answer 1

I have done the calculation in excel. Same is based on the below mentioned steps -

First of all, we will find the net cash for each year.

After that, we will find the PV factor for each basis the given cost of capital rate with the help of formula 1/(1+i)^n, where i is the cost of capital and n is the number of years.

After that, we will multiply the net cashflow with pv factor of respective years. It will be PV of cash flows. Then we will find out the sum of all the PV's, it will be the equal to the required NPV.

Below is the screenshot of the formula applied to get the result in excel.

Below is the required result -

Since NPV is negative, hence project should not be recommended.