Question

Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to be able to sell 51,000 units a year at a price of $69 each. If the new product is a bust, only 26,500 units can be sold at a price of $41. The variable cost of each ball is $25 and fixed costs are zero. The cost of the manufacturing equipment is $5.9 million, and the project life is estimated at 9 years. The firm will use straight-line depreciation over the 9-year life of the project. The firm's tax rate is 35% and the discount rate is 13%. a)   If each outcome is equally likely, what is the expected NPV? Will the firm select the project?

b)

Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $5.41 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. Does the option to abandon change the firm's decision to accept the project? NPV = Will company accept the project?

Answer 1

a) Outflow = 5,900,000

Inflow=

	Contribution	Depreciation	Net Income before taxes	Tax Rate	Net Income After taxes	Net cash flow	PVIFA	Net Cash Inflow
Year 1-9	1,334,000.00	655,555.56	678,444.44	237,455.56	440,988.89	1,096,544.44	5.1317	5,627,137.13

NPV = 5,900,000 -5,627,137.13 =-272, 862.87.

Since NPV is negative, it will not accept the project

b)

	Contribution	Depreciation	Net Income before taxes	Tax Rate	Net Income After taxes	Depreciation	PVIFA
Year 1-9	1,334,000.00	655,555.56	678,444.44	237,455.56	440,988.89	1,096,544.44	0.8850	970,441.83
After sale						5,410,000.00	0.8850	4,787,850.00
						Net Cash Inflow		5,758,291.83

NPV = 5,900,000 -   5,758,291.83 = -141,708.17

Since NPV is negative, it will not accept the project