1. Tidwell Products, Inc., is considering a new product launch. The firm expects to have an annual operating cash flow of $9 million for the next 10 years. Tidwell Products uses a discount rate of 14 percent for new product launches. The initial investment is $38 million. Assume that the project has no salvage value at the end of its economic life.
a. What is the NPV of the new product and how do you calculate it?
b. After the first year, the project can be dismantled and sold for $26 million. If the estimates of remaining cash flows are revised based on the first year's experience, at what level of expected cash flows does it make sense to abandon the project and do you calculate it?
2. Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 10 units per year at $165,000 net cash flow per unit for the next five years. The engineering department has come up with the estimate that developing the machine will take a $6.2 million initial investment. The finance department has estimated that a discount rate of 13 percent should be used.
a. What is the base-case NPV and how do you calculate it?
b. If unsuccessful, after the first year the project can be dismantled and will have an aftertax salvage value of $2.9 million. Also, after the first year, expected cash flows will be revised up to 20 units per year or to 0 units, with equal probability. What is the revised NPV and how do you calculate it?