Question

our CEO has asked you to evaluate whether the firm should launch a new product. Information provided by the consultant is as follows: $20,000 has been spent on doing a market survey, and this cost has been incurred regardless of whether the project is done or not. initial investment: $120,000 composed of $50,000 for the plant and $70,000 net working capital (NWC) Profits of $34,000 every year for 3 years after which the project ends and NWC is recovered. No salvage value for the plant For a discount rate of 10%, what is the NPV?

Answer 1

The market survey cost is incurred irrespective of whether the project is undertaken or not. This implies that the same is a sunk cost and should not be included for NPV analysis.

Initial Investment = Plant Cost + NWC = 50000 + 70000 = $ 120000

Annual Profits = $ 34000 and Tenure = 3 years

Discount Rate = 10 %

NWC is recovered after three years

Therefore, NPV = PV of Annual Profits + PV of Recovered NWC - Initial Investment = 34000 x (1/0.1) x [1-{1/(1.1)^(3)}] + 70000 / (1.1)^(3) - 120000 = 137145.004 - 120000 = $ 17145.004 ~ $ 17145