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A NET PRESENT VALUE PROBLEM IF YOU CAN UNWIND THE STORY HERE IN THIS CASE: ON TUESCON TUESDAY SOFTWARE GIANT AMCOTT POSTED A YEAR END OPERATING LOSS OF $3.5 MILLION. REPORTEDLY, 1.7 MILLI $1.7 MILLION OF THE LOSS STEMMED FROM ITS FOREIGN LANGUAGE DIVISION. WITH SHORT-TERM INTEREST RATES AT 7%, AMCOTT DECIDED TO USE $20 MILLION OF ITS RETAINED EARNINGS TO PURCHASE THREE-YEAR RIGHTS TO MAGICWORD, A SOFTWARE PACKAGE THAT CONVERTS GENERIC WORD PROCESSOR FILES SAVED AS FRENCH TEXT INTO ENGLISH, FIRST-YEAR SALES REVENUE FROM THE SOFTWARE WAS S7 MILLION, BUT THEREAFTER SALES WERE HALTED PENDING A COPYRIGHT INFRINGEMENT SUIT FILED BY FOREIGN, INC. AMCOTT LOST THE SUIT AND PAID DAMAGES OF S1.7 MILLİON. INDUSTRY INSIDERS SAY THE COPYRIGHT VIOLATION PERTAINED TO "A VERY SMALL COMPONENT OF MAGICWORD." RALPH, THE AMCOTT MANAGER WHO WAS FIRED OVER THE INCIDENT, WAS QUOTED AS SAYING, "I'M A SCAPEGOAT FOR THE ATTORNEYS WHO DIDN'T DO THEIR HOMEWORK BEFORE BUYING THE RIGHTS TO MAGICWORD. I PROJECTED ANNUAL SALES OF $7 MILLION PER YEAR FOR THREE YEARS. MY SALES FORECASTS WERE RIGHT ON TARGET. ACTUALLY, WHY WAS RALPH, THE MANAGER, FIRED?

Answer 1

Ralph was actually fired because he failed to act in a proper manner on the information that was given to him. The basis of Ralph’s plan was to generate an amount to the tune of $7 million per year in sales. The initial funding that was required was $20 million.

Doing a net present analysis (NPV) we can see that the NPV of this project was negative and hence this project should not have been undertaken at all in the first place.

NPV = -$20,000,000 + 7,000,000/(1.07)^1 + 7,000,000/(1.07)^2 + 7,000,000/(1.07)^3

= -20,000,000+6,542,056.07+6,114,071.10+5,714,085.14

= -$1,629,787.69 (or -$1.63 million)

Thus we can say that Ralph was fired because he failed to consider the time value of money.