foundations of finance Essay

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A corporation must decide whether to introduce a new product line. The new product will have start-up expenditures, operational expenditures, and then it will have associated incoming cash receipts (sales) and disbursements (Cash paid for materials, supplies, direct labor, maintenance, repairs, and direct overhead) over 12 years. This project will have an immediate (t = 0) cash outflow of 100,000 (which might include all cash paid for the machinery, transportation-in and set-up expenditures, and initial employee training disbursements.) The annual net cash flow (receipts less disbursements) from this new line for years 1–12 is forecast as follows: −54672, −39161, 3054, 7128, 25927, 28838, 46088,
77076, 46726, 76852, 132332, 166047, reflecting two years of running deficits as experience and sales are built up, with net cash receipts forecast positive after that. At the end of the 12 years it's estimated that the entire line becomes obsolete and its scrap value just covers all the removal and disposal expenditures. All values are after-tax, and the required rate of return is given to be 10%. (This also makes the simplifying assumption that the net cash received or paid is lumped into a single transaction occurring on the last day of each year.)
The present value (PV) can be calculated for each year:
Year

Cash flow

Present value

T=0

−100,000

T=1

−49701.8182

T=2

−32364.46281

T=3

2294.515402

T=4

4868.51991

T=5

16098.62714

T=6

16278.29919

T=7

23650.43135

T=8

35956.52284

T=9

19816.38532

T = 10

29629.77288

T = 11

46381.55871

T = 12

52907.69139

The sum of all these present values is the net present value, which equals 65,816.04.
Since the NPV is greater than zero, it would be better to invest in the project than to do nothing, and the corporation should invest in this project if there is no alternative with a higher NPV. There are a few inherent assumptions in this type of discounted cash flow / net present value type analysis:
1. The
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