Question

Liberty Products, Inc., is considering a new product launch. The firm expects to have annual operating cash flow of $9.5 million for the next eight years. The company uses a discount rate of 14 percent for new product launches. The initial investment is $39.5 million. Assume that the project has no salvage value at the end of its economic life.

  

a.

What is the NPV of the new product? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

b.

After the first year, the project can be dismantled and sold for $26.5 million after taxes. If the estimates of remaining cash flows are revised based on the first year’s experience, calculate the equivalent annual cash flows the project must earn to equal the aftertax salvage value. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

   

Answer 1

A)The calculation of NPV is shown below:

NPV = PC of cash inflows - initial outlay

= Cash flow* PVAF(@14%,8 year) - Initial outlay

= $9,500,000* 4.6389 - $39,500,000

= $44,069,207 - $39,500,000

= $4,569,207

b)The calculation for requirement b is shown below:

Remaining time is 7 years.

PV = Pmt (PVIFA factor at 14% and 7 time periods)

PVIFA factor= {(1-(1+r)^ -t)/r} = {( 1-(1+.14)^ -7)/.14} =4.2883

PV= Pmt (PVIFA factor)

$26,500,000=pmt (4.2883)

Pmt = $26,500,000/4.2883

= $6,179,598.011

Annual cash flow = $6,179,598.011