Question

Snow Inc. has just completed development of a new cell phone. The new product is expected to produce annual revenues of $1,400,000. Producing the cell phone requires an investment in new equipment, costing $1,500,000. The cell phone has a projected life cycle of 5 years. After 5 years, the equipment can be sold for $180,000. Working capital is also expected to decrease by $200,000, which Snow will recover by the end of the new product’s life cycle. Annual cash operating expenses are estimated at $820,000. The required rate of return is 8%.

Required:

1. Prepare a schedule of the projected annual cash flows

2. Calculate the NPV using only discount factors from the Present Value of a Single Amount table shown in Present Value Tables.

3. Calculate the NPV using discount factors from both of the tables shown in Present Value Tables.

Answer 1

CASH Flow

$000

Year	InitialOutFlow	Net Inflow (inflow-Operating expense)	Working Capital (Increase)	Scrap Value	Net TOTAL
0	(1,500)		Only Incremental Working Capital is considered in NPV here it is decreasing		(1500)
1		(1400-820)=580			580
2		580			580
3		580			580
4		580			580
5		580		180	760

NPV

$000

	Amount	Present ValueDiscount Factor 8% (B)	Discounted CashFlow (Amt*DF)
Initial Cash Outflow	--(1500)	1	-1500
Year 1 - Net Cash Inflow(w1)	580	0.9259	537.022
Year 2 - Cash Inflow	580	0.8573	497.234
Year 3 - Cash Inflow	580	0.7938	460.404
Year 4 - Cash Inflow	580	0.7350	426.3
Year 5 - Cash Inflow	760	0.6805	517.18
NPV			908.14

NPV = 908,140