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Sarah D is thinking of realsing her 4th full length CD.It will take an upfront $3000 production expense to manf 1000CD.She willl have advertsing and marketing expenses of $5,000the first year,$4,000 the 2nd year, and $3,000 the third year, and $0 the last year.The CD will sell for $16 ea.Marketing /advertising research shows she will sell 400 cds the 1st yr ,300 the 2nd yr, 200 the 3rd yr and 100 the last year.Opportunity cost of captial is 10%
a.Build the project evaluation table est cash in/outflows in their appropriate horizion.
B.Should she fund the project? USe net prsent value analysis
C. Sarah D opp cost rises to 15%.Now should she fund it?
Expert Answer
A)Project ealvaluation table :
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
| Cash outflow | ($3000) | ($5000) | ($4000) | ($3000) | $0 |
| Cash inflow | $6400 | $4800 | $3200 | $1600 | |
| Net cashflow | (3000) | $1400 | $800 | $200 | $1600 |
Note : Cash inflow of each year is computed as follows :
Year 1 – selling price *number of units = 16 *400 =6400
Year 2 – 16* 300 =4800
Year 3 – 16* 200 =3200
Year 4- 16 * 100 =1600
B)Npv method uses the net flow and the rate which is given as 10 %
NPV = Net cash flow * PV (r,n) – Initial cash outflow at year 0
Hence PV of cashflows = 1400* PV (10%,1) + 800 * PV (10%,2) + 200 * PV ( 10%,3) + 1600 * PV (10%,4)
= 1400* 0.909 + 800* 0.826 + 200 * 0.751 + 1600 * 0.683
=$3176
NPV = PV of cash flows – cash outflow initially
=$ 3176 – $3000
=$176
Since the NPV is positive hence the project shall be funded.
C) Let us compute the NPV using rate 15 %
PV of cash flows = $1400 * 0.869 + $800 * 0.756 + $ 200 * 0.657 + $1600 * 0.572
= $2870
NPV = PV of cash flows – cash outflow
=$2870 – $3000
=($130)
Since the NPV is negative the project shall not be funded as the outflow is higher than the inflows.
Note : The Pv can be found from pv table or from the formula 1/(1+r)^n.
