Solved: Sarah D is thinking of realsing her 4th full length CD.It will take an upfront $3000 production

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.

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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.

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