Consider two mutually exclusive new product launch projects that Nagano Golf is
ID: 2760027 • Letter: C
Question
Consider two mutually exclusive new product launch projects that Nagano Golf is considering. Assume the discount rate for Nagano Golf is 16 percent. (Do not round intermediate calculations. Round your "PI" answers to 3 decimal places (e.g., 32.161) and other answers to 2 decimal places. (e.g., 32.16))
Project A: Nagano NP-30. Professional clubs that will take an initial investment of $670,000 at time 0. Next five years (Years 1–5) of sales will generate a consistent cash flow of $305,000 per year. Introduction of new product at Year 6 will terminate further cash flows from this project.
Project B: Nagano NX-20. High-end amateur clubs that will take an initial investment of $740,000 at Time 0. Cash flow at Year 1 is $220,000. In each subsequent year cash flow will grow at 10 percent per year. Introduction of new product at Year 6 will terminate further cash flows from this project.
Year NP-30 NX-20 0 –$ 670,000 –$ 740,000 1 305,000 220,000 2 305,000 242,000 3 305,000 266,200 4 305,000 292,820 5 305,000 322,102
________________________________________ Complete the following table: NX-30 NX-20 Payback years years IRR % % PI NPV $ $
Explanation / Answer
Solution:
Calculation of Payback Period:
Payback Period for NP-30:
From the above table it is clear that payback period shall lie between 2 to 3 years. Since upto 2 years a sum of 610,000 shall be recovered balance of 60,000 shall be recovered in the part of 3rd year computed as follows:
= 60,000/ 305,000
= 0.197 year
Thus, total cash outlay of 670,000 will be recovered in 2.197 years
Payback Period for NX-20:
From the above table it is clear that payback period shall lie between 3 to 4 years. Since upto 3 years a sum of 728,200 shall be recovered balance of 11,800 shall be recovered in the part of 4th year computed as follows:
= 11,800/ 292,820
= 0.04 years
Thus, total cash outlay of 740,000 will be recovered in 3.04 years
Calculation of IRR:
Since by discounting cash flows at 16% we are getting values far from zero. Therefore, let us discount cash flows using 35% discount rate for project NP-30 & 25% discount rate for project NX-20.
Since by discounting cash flows 35% we are getting value of NP-30 is positive and discounting cash flows 25% we are getting value of NX-20 is negative. Therefore, let us discount cash flows of project NP-30 using 40% discount rate and project NX-20 using discount rate of 20%.
The Internal rate can be obtained by interpolation:
IRR = LR + {(NPV at LR)/ (NPV at LR-NPV at HR)} * (HR – LR)
Project NP-30 = 35 + {(7,100/ (7,100 - (-49,630)} * (40-35)
= 35 + 0.625
= 35.625%
Project NX-20 = 20 + {(35,962/ (35,962 - (-47,119)} * (25 - 20)
= 20 + 2.164
= 22.164%
Calculation of Profitability Index:
PI (NP-30) = 998,570/ 670,000 = 1.490
PI (NX-20) = 855,037/ 740,000 = 1.155
Calculation of Net Present Value:
NPV (NP-30) = 998,570 - 670,000 = 328,570
NPV (NX-20) = 855,037 - 740,000 = 115,037
Summary:
Year NP-30 NX-20 Cumulative cash inflows NP-30 Cumulative cash inflows NX-20 0 (670,000) (740,000) 1 305,000 220,000 305,000 220,000 2 305,000 242,000 610,000 462,000 3 305,000 266,200 915,000 728,200 4 305,000 292,820 1,021,020 5 305,000 322,102