Net Present Value Analysis Amount Descriptions Present Value Tables Instructions
ID: 2392673 • Letter: N
Question
Net Present Value Analysis Amount Descriptions Present Value Tables Instructions Emery Communications Company is considering the production and marketing of a communications system that will increase the efficiency of messaging for small businesses or branch offices of large companies. Each unit hooked into the system is assigned a mailbox number, which can be matched to a telephone extension number, providing access to messages 24 hours a day. Up to 20 units can be hooked into the system allowing the delivery of the same message to as many as 20 people. Personal codes can be used to make messages confidential. Furthermore messages can be reviewed, recorded, cancelled, replied to, or deleted all during the same message playback. Indicators wired to the telephone blink whenever new messages are present To produce this product, a $1.75 million investment in new equipment is required. The equipment will last 10 years but vill need major maintenance costing $150,000 at the end of its sixth year. The salvage value of the equipment at the end of 10 years is estimated to be $100,000. It this new system is produced, working capital must also be increased by $90,000. This capital will be restored at the end of the product's 10-year life cycle. Revenues from the sale of the product are estimated at $1.65 million per year Cash operating expenses are estimated at $1.32 million per year Required: 1. Prepare a schedule of cash flows for the proposed project (Assume that there are no income taxes) 2. Assuming that Emery's cost of capitals 12% compute the pro ect s NPV Should the product be produced? 949 PMExplanation / Answer
Emery Communications Company
Schedule of cash flows
Cost of capital = 12%
Annual cash inflows = Revenue from sale of goods - Cash operating expenses
= 1,650,000 - 1,320,000
= $330,000
Annual cash inflows of $330,000 will take place for 9 years. In the 10th year, net cash inflow will be $520,000 as calculated in the above schedule.
Present value of cash inflows = 330,000 x PVAF(12% , 9) + 520,000 x PVF(12%, 10)
= 330,000 x 5.328 + 520,000 x 0.322
= 1,758,240 + 167,440
= $1,925,680
Present value of cash outflows = 18,40,000 + 150,000 x PVF(12%, 6)
= 1,840,000 + 150,000 x 0.507
= 1,840,000 + 76,050
= $1,916,050
NPV of the project = Present value of cash inflows - Present value of cash outflows
= 1,925,680 - 1,916,050
= $9,630
Since NPV of the project is positive, hence project may be undertaken. Hence the product should be produced
Year 0 $ Cost of equipment -1,750,000 Working capital requirement - 90,000 Total - 1,840,000 Year 1-5 Revenues from sale of product 1,650,000 Less: Cash operating expenses - 1,320,000 Net cash inflow 330,000 Year 6 Maintenance cost - 150,000 Revenue from sale of goods 1,650,000 Cash operating expenses - 1,320,000 Net cash inflow 180,000 Year 7-9 Revenue from sale of goods 1,650,000 Cash operating expenses - 1,320,000 Net cash inflow 330,000 Year 10 Revenue from sale of goods 1,650,000 Cash operating expense - 1,320,000 Working capital release 90,000 Scrap value of equipment 100,000 Net cash inflow 520,000