1. a. Hawks Ventures has designed a new fuel efficient motor for their deluxe RV
ID: 2645484 • Letter: 1
Question
1.
a. Hawks Ventures has designed a new fuel efficient motor for their deluxe RV. Product development will continue for the next four years at an estimated cost of $250,000 annually, with the first payment to be made immediately. (Hint, 3 years left to pay for the annual cost.) The motor will be sold upon completion of the product development stage, generating annual cash flows of $200,000 for the next 10 years. Assuming a discount rate of 10%, what is the NPV of this investment?
b. Assuming a forecast bias of +10% on the costs and -8% on the cash flows, should the project be accepted?
Explanation / Answer
A. Present Value of Cash Outflows = 250,000 x (1 + 1 / (1+0.10)1 + 1 / (1+0.10)2 + 1 / (1+0.10)3) = $871,713
Present Value of Cash Inflows = 200,000 x PVAF(10%, 10years) = $1,228,913
NPV = 1,228,913 - 871,713 = $357,200
B. New Cash Outflow = 250,000 x 110% = $275,000
New Cash Inflow = 200,000 x 92% = $184,000
Present Value of Cash Outflows = 275,000 x (1 + 1 / (1+0.10)1 + 1 / (1+0.10)2 + 1 / (1+0.10)3) = $958,884
Present Value of Cash Inflows = 184,000 x PVAF(10%, 10years) = $1,130,600
NPV = 1,130,600 - 958,884 = $171,716. Yes the project be accepted since the NPV is positive.
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