Hit or Miss Sports is introducing a new product this year. If it's seeing at night soccer balls are a hit, the firm expects to be able to sell 50,000 units a year at a price of $60 each. If the new product is a bust, only 30,000 units can be sold at a price of $55. The variable cost of each ball is $30, and fixed costs are zero. The cost of the manufacturing equipment is $6 million, and the project life is estimated at 10 years. The firm will use straight line depreciation over the ten year life of the project. The firm's tax rate is 35 percent, and the discount rate is 12 percent.
If each outcome is equally likely, what is expected NPV? Will the firm accept the project?
Assume now that the firm can abandon the project and sell off the manufacturing equipment for $5.4 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. Does the option to abandon change the firm's decision to accept the project?
DISCUSSION
How can the use of NPV assist in the measurement and evaluation of corporate projects to ensure that stakeholder interests are being met?
Describe how the concept of inflation affects the principle of time value of money? Why must a firm keep this concept at heart when evaluating a new or potential project?
Under what conditions will the IRR and NPV methods give conflicting results for mutually exclusive decisions?
Why the profitability index is more appropriately described as a variation on the NPV technique than as a variation on the IRR technique?