Question

1. You are considering investing $150,000 today to develop a new marketing campaign for a new product to be offered for the next 3 years.  If the economy is booming, you expect this campaign to result in $100,000 of additional cash flow per year.  If the economy is average, $60,000 additional annual cash flow is expected.  But if we are in a recession, no one will buy your product and the marketing will have no incremental effect on cash flow.  The three economic states are equally likely.  What is the NPV of this campaign if the required rate of return is 12%?

Answer 1

Net Present Value (NPV) of the Campaign

Step-1, Expected Cash Flow per year

Here, the economic states are equally likely, therefore, the expected cash will be computed as follows

Expected Cash Flow = [$100,000 x 1/3] + [$60,000 x 1/3] + [$0 x 1/3]

= $33,333 + $20,000 + $0

= $53,333 per year

Step-2, Net Present Value (NPV)

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= CF1/(1 + r)¹ + CF2/(1 + r)² + CF3/(1 + r)³] – Initial Investment

= [$53,333/(1 + 0.12)¹] + [$53,333/(1 + 0.12)²] + [$53,333/(1 + 0.12)³ ] - $150,000

= [$53,000 / 1.12] + [$53,333 /1.25440] + [$53,333 / 1.40493] - $150,000

= [$47,619 + $42,517 + $37,961] - $150,000

= $128,097 - $150,000

= -$21,903 (Negative NPV)

“Therefore, the Net Present Value (NPV) of the Campaign would be -$21,903 (Negative NPV)”