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Homework answers / question archive / Nanosoft Corporation is thinking about marketing a new software product
Nanosoft Corporation is thinking about marketing a new software product. Up-front costs to market and develop the product are $4.96 million. The product is expected to generate profits of $1.08 million per year for ten years. The company will have to provide product support expected to cost $99 000 per year in perpetuity. Assume all profits and expenses occur at the end of the year.
a. What is the NPV of this investment if the cost of capital is 5.7%? Should the firm undertake the project? Repeat the analysis for discount rates of 1.6% and 14.3%, respectively.
b. What is the IRR of this investment opportunity?
c. What does the IRR rule indicate about this investment?
a) NPV (5.7%) = -4960000+1080000/0.057*(1-1/1.057^10)-99000/0.057
=$1,366,263.33
The firm should undertake the project as the NPV is positive
NPV (1.6%) = -4960000+1080000/0.016*(1-1/1.016^10)-99000/0.016
= - $1,240,101.10 (Firm should not undertake project at 1.6% discount rate)
NPV (14.3%) = -4960000+1080000/0.143*(1-1/1.143^10)-99000/0.143
= - $84,242.76 (Firm should not undertake project at 14.3% discount rate)
b) IRR (r) of the project is given by
-4960000+1080000/r*(1-1/(1+r)^10)-99000/r = 0
Since the project has positive NPV at 5.7% but negative NPV at 1.6% and 14.3%
project has two IRRs , one between 1.6% and 5.7% and another between 5.7% and 14.3%
Solving r = 0.021137 or 2.1137% and 0.13801532 or 13.8015%
So, there are two IRRs : 2.1137% and 13.8015%
c) The IRR rule indicates that the firm's cashflows changes sign twice , first from Negative to positive from initial negative cash outflow to 1st year positive cashinflow of $1080000-$99000 =$981000
and then from positive cashinflow in year 10 of $1080000 to negative cashoutflow of $99000 in year 11
So there should be two IRRs
