Question

X Company has an opportunity to accept a special order that will result in immediate profit of $67,000. After doing some market research that cost $4,000, the marketing manager believes that if X Company accepts the order, the company will lose regular customers. Specifically, she believes the effect will be lost profits of $8,500 in each of the next 5 years.

Assuming a discount rate of 6%, what is the net present value of accepting the special order?

Answer 1

If X Company accepts the special order it will lead to a immediate profit of $ 67,000.As it will lead to a immediate profit, there is no need to discount it as it is already at present value I.e $67,000.

The market research cost of $ 4,000 is a sunk cost. Hence not to be considered for calculating net present value.

Present value of the profits which will be lost by the company if it accepts special orders: = $8,500 * Annuity factor @ 6% for 5 years = $8,500 * 4.2124 = $ 35,805 ( rounded off)

Annuity factor formula =( 1- (1+r)^-n )/ r

Net present value of accepting the special order = Immediate profits to be earned by the company after accepting special order - Present value of profits which will be lost by the company if it accepts special orders = $ 67,000 - $ 35,805 = $ 31,195.

Hence special order should be accepted by the company as net present value is positive