Question

Webster's wants to introduce a new product that has a start-up cost of \$7,800. The product...

Webster's wants to introduce a new product that has a start-up cost of \$7,800. The product has a 2-year life and will provide cash flows of \$6,700 in Year 1 and \$4,300 in Year 2. The required rate of return is 31 percent. Should the product be introduced? Why or why not?

 A. Yes; the NPV is \$1,105.15. B. No; the IRR is 28.72 percent. C. Yes; the IRR is 28.72 percent D. No; the NPV is −\$1,105.15

Answer: Option B is correct.

Net present value=-Initial investment+ Cash flow in year 1/(1+required rate of return)^1+Cash flow in year 2/(1+Required rate of return)^2
Initial investment=\$7,800
The product has a 2-year life
Cash flow in year 1=\$6,700
Cash flow in year 2=\$4300
Required rate of return=31%
Net present value=-\$7,800+\$6,700/(1+31%)^1+\$4300/(1+31%)^2
=-\$7,800+\$6,700/(1+31%)^1+\$4300/(1+31%)^2
=-\$7,800+\$6,700/(1.31)^1+\$4300/(1.31)^2
=-\$7,800+\$6,700/1.31+\$4300/1.7161
=-\$7,800+\$5114.503817+\$2505.681487
=-179.814696

Calculating IRR:
We can calculate the IRR using excel. We got the value of IRR=28.72%

As the project has a negative NPV, it should not be introduced as it will decrease the shareholders' value.