Applied Nanotech is thinking about introducing a new surface cleaning machine. T

Question

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 15 units per year at $305,000 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 $15 million initial investment. The finance department has estimated that a 16 percent discount rate should be used. a. What is the base-case NPV? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Negative amount should be indicated by a minus sign. after the first year the project can be dismantled and will have an aftertax salvage value of $11 million. Also, after the first year, expected Cashflows will be revised up to 20 units per year or to 0 units, with equal probability. What is the revised NPV? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Annual cash flows for 5 years = 15 units * $305,000 = $4,575,000

Discount rate = 16%

Present value of annuity = Annuity *{1-(1+r)-n}/r

Present value for annual cash flows = $4,575,000*(1-1.16-5)/0.16 = $4,575,000*3.2743 = $14,979,922.50

Net present value = -Initial investment + Present value of cash flows = -$15,000,000 + $14,979,922.50 = $20,077.50

The company will abandon the project if unit sales are not revised upward. If the unit sales are revised upward, the after tax cash flows for the project over the last four years will be:

New annual cash flow = 20* $305,000 = $6,100,000

The NPV of the project will be the initial cost, plus the expected cash flow in year one based on 10 unit sales projection, plus the expected value of abandonment, plus the expected value of expansion. We need to remember that the abandonment value occurs in year 1, and the present value of the expansion cash flows are in year one, so each of these must be discounted back to today. So, the project NPV under the abandonment or expansion scenario is:

NPV = –$15,000,000 + $4,575,000 / 1.16 + 0.50($11,000,000) / 1.16 + [.50($6,100,000)(PVIFA16%,4)] / 1.16

NPV = 1,237,956.28

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