1. [10 points Suppose a new software feature is expected to drive an additional

Question

1. [10 points Suppose a new software feature is expected to drive an additional $50,000 of revenue each year for the next four years. How much should we be prepared to invest in the development of that feature assuming a 2% annual rate of return? Round your answer to the nearest hundred dollas. Be sure to show all of your work or you won't receive full credit. 2, 5 points) Suppose that management is willing to invest $100,000 at the start of the develop- ment of the feature above. If the assumptions above all hold true, what is the net present value of the investment? Be sure to show all of your work or you won't receive full credit

Explanation / Answer

1.) Additional revenue from new feature = $50,000

Additional revenue is for 4 years

rate of return = 2%

The company can maximum invest upto the amount that will make NPV zero

NPV is the sum of present value of all cash flows

If NPV is greater than zero then company should undertake this project as it is creating value for the company

To calculate the present value (PV) of a cash flow, we need to discount it by the required return.

PV = cash flown/(1+r)n,

where cash flown is cash flow in period n, r is required rate of return, n is time period

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ................... + CFn-1/(1+r)n-1 + CFn/(1+r)n

r is return.

In this case, NPV is zero

we know periodic cash flow and have to find initial investment

CF1 = CF2 = CF3 = CF4 = $50,000

We need to find CF0

r is 2%

Now putting all values in the equation

0 = CF0 + 50000/(1+0.02)1 + 50000/(1+0.02)2 + 50000/(1+0.02)3 + 50000/(1+0.02)4

CF0 = -$190,400, where negative sign indicates cash outflow

So the company should be ready to invest maximum of $190,400 for this new feature

2.) If management is willing to invest $100,000 then to calculate NPV we will use the same previous formula but now we will know the initial investment and we need to find NPV

CF0 = -$100,000, negative sign shows cash outlow

CF1 = CF2 = CF3 = CF4 = $50,000

r = 2%

S, NPV = -100000 + 50000/(1+0.02)1 + 50000/(1+0.02)2 + 50000/(1+0.02)3 + 50000/(1+0.02)4

NPV = $90,386

NPV of this new feature is $90,386

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.