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Net Present Value Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product: • Expected annual revenues: $700,000 • Projected product life cycle: five years • Equipment: $750,000 with a salvage value of $100,000 after five years • Expected increase in working capital: $100,000 (recoverable at the end of five years) • Annual cash operating expensel: estimated at $420,000 • Required rate of return: 8 percent The present value tables provided in Exhibit 19B
Net Present Value
Carsen Sorensen, controller of Thayn Company, just received the following data associated with production of a new product:
• Expected annual revenues: $700,000 • Projected product life cycle: five years • Equipment: $750,000 with a salvage value of $100,000 after five years • Expected increase in working capital: $100,000 (recoverable at the end of five years) • Annual cash operating expensel: estimated at $420,000 • Required rate of return: 8 percent
The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems. Required: 1. Estimate the annual cash flows for the new product. Enter cash outflows as negative amounts and cash inflows as positive amounts.
Year 0 1-4 5
Cash Flow
2. Using the estimated annual cash flows, calculate the NPV.
Expert Solution
| 1) Computation of Expected Cash Flows: | |||
| Particulars | Year 0 | Year 1-4 | Year 5 |
| Initial investment | -750,000 | ||
| Increase in WC | -100,000 | ||
| Expected annual revenues | 700,000 | 700,000 | |
| Annual Expenses | -420,000 | -420,000 | |
| Salvage value | 100,000 | ||
| Release of working capital | 100,000 | ||
| Expected Cash Flows | -850,000 | 280,000 | 480,000 |
| 2) Computation of Net Present Value: | |||
| Year | Cash Flow | PVF | Present values |
| Year 0 | -850,000 | 1 | -850,000 |
| Year 1-4 | 280,000 | 3.3121 | 927,388 |
| Year 5 | 480,000 | 0.6806 | 326,688 |
| Net Present Value | 404,076 |
| 3) Computation of Net Present Value when Annual Revenues overestimated by $140,000: | |||
| Particulars | Year 0 | Year 1-4 | Year 5 |
| Initial investment | -750,000 | ||
| Increase in WC | -100,000 | ||
| Expected annual revenues | 560,000 | 560,000 | |
| Annual Expenses | -420,000 | -420,000 | |
| Salvage value | 100,000 | ||
| Release of working capital | 100,000 | ||
| Expected Cash Flows | -850,000 | 140,000 | 340,000 |
| Year | Cash Flow | PVF | Present values |
| Year 0 | -850,000 | 1 | -850,000 |
| Year 1-4 | 140,000 | 3.3121 | 463,694 |
| Year 5 | 340,000 | 0.6806 | 231,404 |
| Net Present Value | -154,902 |
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