Question

William's Co. is considering spending $15,000 at Time 0 to test a new product. Depending on the test results, the firm may decide to spend $58,000 at Time 1 to start production of the product. If the product is introduced and it is successful, it will produce aftertax cash flows of $45,000 a year for Years 2 through 4. The probability of successful test and investment is 62 percent. What is the net present value at Time 0 given a 14 percent discount rate

Answer 1

Answer:

$10,275.03

Explanation:

Years                                                  0            1             2           3            4  

Cash flow                                     -15000  -58000   45000  45000   45000

Successful chance result (62%)  -9300   -35960    27900   27900   27900  

Considered cash flow                 -15000  -35960    27900  27900    27900

Discount factor (14%)                        1         0.877      0.769    0.675     0.592  

Present value                         -15000  (31,543.86)  21,468.14  18,831.71 16,519.04

Net present value = -$15000 - $31,543.86 + 21,468.14  + 18,831.71 + 16,519.04

Net present value = $10,275.03