Question

Based on the initial four-year economic feasibility study below --

Decision Variables Year of Project Incr Sales $ 50,000.00 ReduSuppl $ 5,000.00 MASaving $ 20,000.00 1 Total - $ 2 55,000.00 $ 3 55,000.00 $ $ 1.00 Sales and savings One-time Saving Discount Rate 4 55,000.00 20,000.00 1.00 DevCost $(87,000.00) Equipment $ (3,000.00) 1.00 1.00 PV of Benefit - $ 55,000.00 $ 55,000.00 $ 75,000.00 $ 185,000.00 License $ (10,000.00) Operator $(22,000.00) MAConnec $ (8,000.00) $ (90,000.00) Discount 0% $ $ Dev. and Equipment License and Supply Hiring and training Communication Cost Total Cost Discount Rate (10,000.00) $ (22,000.00) $ (10,000.00) $ (22,000.00) $ $ (32,000.00) $ 1.00 (10,000.00) (22,000.00) (8,000.00) (40,000.00) 1.00 $ (90,000.00) $ 1.00 (32,000.00) $ 1.00 PV of All Costs $ (90,000.00) $ (32,000.00 $ (32,000.00 $ (40,000.00) $ (194,000.00) Overall NPV (9,000.00) Overall ROI -4.64%

a. If the project is allowed to proceed even with a negative ROI, what are the possible reasons for reaching such a decision?

b. Up to how much could the development cost be for the project to at least break even?

c. Similar to part b, up to how much could the operator hiring and training cost be for the project to at least break even?

d. If the cash flow discount rate is changed from 0% to 5%, will the NPV increase or decrease? Briefly explain your answer.

Answer 1

Please find the solution in given screen shots,

Amount in $.

a) Possible Reason to allow the said project with negative ROI. ROI is a measure to get return on investment for a given period of time - generally for a period of one year. In the problem the negative ROI is on 4 Years Project - not for one Year. On annualising it will reach around negative 1% Most of the projects have the major chunk of capex at the beginning of year in this case there are operational expenses as well which will give opportunity to be managed and reduced once project starts No Salvage Value is considered at Terminal for the Initial Outlay - since Capex is nearly half of the total cash outflow it may have some Salvage value which bring the NPV positive or Zero b) Break Even Point - by Development Cost As the Over all Return -9,000.00 Hence this amount should be reduced from Development Cost to bring the project at break even point Development Cost to be 90000-9000 = 81000 Break Even Point - by Hireing & Training Cost As the Over all Return -9,000.00 Hence this amount should be reduced from Hiring & Training Cost to bring the project at break even point Total Hiring & Training Cost = 20000 + 20000 20000 = 60000 Hiring & Training cost to be 60000-9000 = 51000 Hiring & Training Cost to be / year 51000/3 = 17000

d) NPV - at 5% Discount Rate Tota 2 | 3 55,000.00 55,000.00 0 55,000.00 20,000.00 0.8638 64,787.82 0.9524 0.9070 52,380.95 49,886.62 167,055.39 Year Sales & Saving One-time Saving Discount Factor PV of Benefit Dev and Equipment License and Supply Hiring & Training Communication Cost Total Cost Discount Factor PV of all Cost 0 -90,000.00 | -10,000.00 -10,000.00 -22,000.00 -22,000.00 -10,000.00 -22,000.00 -8,000.00 -40,000.00 0.8638 -34,553.50 -184,054.64 -90,000.00 -32,000.00 -32,000.00 0.9524 0.9070 -30,476.19 -29,024.94 -90,000.00 Overall NPV - 16,999.24 NPV will decrease to negative 16,999.24 Since the NPV at 0% discount is negative - it will decrease even further if we increase the discounting rate The total PV of inflow will be always lessor than the total PV of Cost. The Cost has to be managed or the project is not feasible.

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