A company is considering the launch of a new product Investm

A company is considering the launch of a new product: Investment required in equipment: £150000; Project life cycle: 5 years, Value of equipment in year 6: £10000, Cash inflow as follows: £000 60 62 65 70 70 Year 2 3 4 5 An existing product can be discontinued immediately or retained instead of the new product for five years. If retained a cash inflow of £12000 p.a would be expected Discount rate (cost of capital) is 15% pa. Calculate the expected net present value of the new product · Advise the company whether to launch the new product or retain the existing one.

Solution

Expected net present value of the new product: Year Cashflow PV Factor @ 15% Present Value 1 60000 0.869565217 52174 2 62000 0.756143667 46881 3 65000 0.657516232 42739 4 70000 0.571753246 40023 5 70000 0.497176735 34802 6 10000 0.432327596 4323 (Salvage value) Present value of cash inflows 220942 Less: Initial investment 150000 Net present value 70942 Expected net present value of the existing product: Year Cashflow PV Factor @ 15% Present Value 1 12000 0.869565217 10435 2 12000 0.756143667 9074 3 12000 0.657516232 7890 4 12000 0.571753246 6861 5 12000 0.497176735 5966 Present value of cash inflows 40226 Less: Initial investment 0 Net present value 40226 Advise: It is better to launch the new product since it will result in increased net present value of $30716 (70942-40226)