Question

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 1

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.