Question

X Company is planning to launch a new product. A market research study, costing $150,000, 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 $107,000 in each of the last two years. The company plans to undertake an immediate advertising campaign that will cost $78,000. New manufacturing equipment will have to be purchased for $310,000; it will have zero disposal value at the end of the four years. Assuming a discount rate of 7%, what is the net present value of launching the new product?

Answer 1

Solution:

Calculation of Total Initial Investment	$
Cost of new manufacturing equipment	3,10,000.00
Add: Expenditure for advertising campaign	78,000.00
Total Initial Cash Outflow	3,88,000.00

Note: Cost of market research study $150,000 will not be considered as initial cash outflow as it has already been incurred and will be considered as sunk cost.

Depreciation of New Equipment as per Straight Line Method:

= Cost – Salvage value / Number of years

= $310,000 – 0 / 4    = $77,500

Calculation of Present value of cash inflows from the new product.

Year	Profits from Sales $	Depreciation $	Cash Inflows = Profits from Sales $ + Depreciation	Discounting Factor @ 7%	Present Value of Cash Inflows $
1	1,51,000.00	77,500.00	2,28,500.00	0.9346	2,13,551.40
2	1,51,000.00	77,500.00	2,28,500.00	0.8734	1,99,580.75
3	1,07,000.00	77,500.00	1,84,500.00	0.8163	1,50,606.96
4	1,07,000.00	77,500.00	1,84,500.00	0.7629	1,40,754.17
				Total Present Value of Cash Inflows $	7,04,493.28

Net Present Value = Total Present Value of Cash Inflows $ - Total Initial Cash Outflow $

                                      = $704,493.28 - $388,000.00 = $316,493.28

As the Net Present Value of the new product is positive, the company is recommended to launch the new product.