Question

M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video game that requires an initial investment of $7.6 million. The company expects a total annual operating cash flow of $1.36 million for the next 10 years. The relevant discount rate is 10 percent. Cash flows occur at year-end.

a.	What is the NPV of the new video game? (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 one year, the estimate of remaining annual cash flows will be revised either upward to $2.26 million or downward to $291,000. Each revision has an equal probability of occurring. At that time, the video game project can be sold for $2.66 million. What is the revised NPV given that the firm can abandon the project after one year? (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) PV of cash inflows can be calculated using PV function on a calculator

N = 10, PMT = 1,360,000, I/Y = 10%, FV = 0

=> Compute PV = $8,356,611.26

NPV = 8,356,611.26 - 7,600,000 = $756,611.26

b) Let's calculate the value of the firm if cash flows are revised upwards.

N = 9, PMT = 2,260,000, I/Y = 10%, FV = 0 => Compute PV = $13,015,393.82

NPV (upwards) = ($1,360,000 + $13,015,393.82) / (1 + 10%) - 7,600,000 = $5,468,539.84

If cash flows are revised downwards, it makes sense to sell the project at $2.66m

=> NPV (downwards) = (1.36m + 2.66m) / 1.10 - 7,600,000 = -3,945,454.54

=> Revised NPV = 50% x 5,468,539.84 + 50% x (- 3,945,454.54) = $761,542.65