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X Company is considering launching a new product. After conducting a market research study that cost...

X Company is considering launching a new product. After conducting a market research study that cost $5,000, the company estimates sales of 7,900 units in each of the next 4 years, with a contribution margin of $6.10 per unit. Additional fixed costs will be $11,958. Equipment costing $120,000 will have to be purchased; the equipment will have no salvage value at the end of 4 years. What is the internal rate of return of launching the new product?

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Answer #1

Solution:

Initial investment in equipment = $120,000

Annual cash inflows = Contribution margin - Fixed costs

= (7900*$6.10) - $11,958 = $36,232

Project duration = 4 years

Let IRR = i

Now at IRR, present value of cash inflows is equal to initial investment.

Therefore

$36,232 * cumulative PV Factor at i for 4 periods = $120,000

Cumulative PV Factor at i for 4 periods = $120,000 / $36,232 = 3.31199

Refer PV Factor table, this factor lies at i = 8%

Therefore IRR = 8%

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