Question

You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost $905,000 to develop up front (year O), and you expect revenues the first year of $801,000, growing to $1.48 million the second year, and then declining by 40% per year for the next 3 years before the product is fully obsolete. In years 1 through 5, you will have fixed costs associated with the product of $110,000 per year, and variable costs equal to 55% of revenues. a. What are the cash flows for the project in years 0 through 5? b. Plot the NPV profile for this investment using discount rates from 0% to 40% in 10% increments. c. What is the project's NPV if the project's cost of capital is 10.4%? d. Use the NPV profile to estimate the cost of capital at which the project would become unprofitable; that is, estimate the project's IRR.

Answer 1

Cash flow for the year 0 to 5

Period	Project Cost	Revenue	Fixed cost	Variable Cost	Net Cash flow
Year 0	$        9,05,000				$       (9,05,000)
Year 1		$          8,01,000	$        1,10,000	$        4,40,550	$          2,50,450
Year 2		$        14,80,000	$        1,10,000	$        8,14,000	$          5,56,000
Year 3		$          8,88,000	$        1,10,000	$        4,88,400	$          2,89,600
Year 4		$          5,32,800	$        1,10,000	$        2,93,040	$          1,29,760
Year 5		$          3,19,680	$        1,10,000	$        1,75,824	$             33,856

NPV using discount rate 0% to 40%

						Discount rate
Period	Project Cost	Revenue	Fixed cost	Variable Cost	Net Cash flow	0%	10%	20%	30%	40%
Year 0	$        9,05,000				$       (9,05,000)	$ (9,05,000)	$ (9,05,000)	$      (9,05,000)	$      (9,05,000)	$   (9,05,000)
Year 1		$          8,01,000	$        1,10,000	$        4,40,550	$          2,50,450	$   2,50,450	$    2,27,682	$ 2,08,708.33	$ 1,92,653.85	$ 1,78,892.9
Year 2		$        14,80,000	$        1,10,000	$        8,14,000	$          5,56,000	$   5,56,000	$    4,59,504	$ 3,86,111.11	$ 3,28,994.08	$ 2,83,673.5
Year 3		$          8,88,000	$        1,10,000	$        4,88,400	$          2,89,600	$   2,89,600	$    2,17,581	$ 1,67,592.59	$ 1,31,816.11	$ 1,05,539.4
Year 4		$          5,32,800	$        1,10,000	$        2,93,040	$          1,29,760	$   1,29,760	$        88,628	$      62,577.16	$      45,432.58	$     33,777.6
Year 5		$          3,19,680	$        1,10,000	$        1,75,824	$             33,856	$       33,856	$        21,022	$      13,605.97	$        9,118.41	$        6,295.0
						$   3,54,666	$    1,09,416	$         (66,405)	$      (1,96,985)	$   (2,96,822)

@ Cost of Capital of 10.4%

						Cost of capital
Period	Project Cost	Revenue	Fixed cost	Variable Cost	Net Cash flow	10.40%
Year 0	$        9,05,000				$       (9,05,000)	$      (9,05,000)
Year 1		$          8,01,000	$        1,10,000	$        4,40,550	$          2,50,450	$ 2,26,856.88
Year 2		$        14,80,000	$        1,10,000	$        8,14,000	$          5,56,000	$ 4,56,180.42
Year 3		$          8,88,000	$        1,10,000	$        4,88,400	$          2,89,600	$ 2,15,224.32
Year 4		$          5,32,800	$        1,10,000	$        2,93,040	$          1,29,760	$      87,350.33
Year 5		$          3,19,680	$        1,10,000	$        1,75,824	$             33,856	$      20,643.83
						$        1,01,256

IRR = 1101

						Cost of capital
Period	Project Cost	Revenue	Fixed cost	Variable Cost	Net Cash flow	15.85%
Year 0	$        9,05,000				$       (9,05,000)	$      (9,05,000)
Year 1		$          8,01,000	$        1,10,000	$        4,40,550	$          2,50,450	$ 2,16,184.72
Year 2		$        14,80,000	$        1,10,000	$        8,14,000	$          5,56,000	$ 4,14,269.27
Year 3		$          8,88,000	$        1,10,000	$        4,88,400	$          2,89,600	$ 1,86,256.07
Year 4		$          5,32,800	$        1,10,000	$        2,93,040	$          1,29,760	$      72,037.18
Year 5		$          3,19,680	$        1,10,000	$        1,75,824	$             33,856	$      16,223.91
						$            (28.85)