a. A magazine publisher wants to launch a new magazine geared to college student

Question

a. A magazine publisher wants to launch a new magazine geared to college students. The project's initial investment is $620. The project's cash flows that come in at the end of each year are $170 for 9 consecutive years beginning one year from today. What is the project's NPV if the required rate of return is 8.25%?

b. A research division of a large consumer electronics company has developed a new type of mp3 player. The project will require an immediate cash outflow of $1,665,321. The new project is expected to produce cash flows of $500,000 per year for 4 consecutive years beginning at the end of year one. What is this projects internal rate of return?

c. A manufacturer of backpacks plans to introduce a new line. Equipment and production costs will be incurred immediately and will total $7,272,727. The company expects to earn a profit of $20 per backpack, and sales are estimated to be 100,000 in the first year (assume that the cash flow comes in at the end of the year). Sales are then expected to grow by 10% per year in each of the next three years (in year 2, year 3, and year 4) but the price is expected to remain at $20 throughout.

What is the internal rate of return of this project?

Should the company produce the backpacks if the required rate of return is 12%? Yes or no

Explanation / Answer

a.

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

NPV = $431.02

b.

IRR is the rate at which NPV = 0

NPV = -1665321 + 500000/(1+IRR)^1 + 500000/(1+IRR)^2 + 500000/(1+IRR)^3 + 500000/(1+IRR)^4 = 0

By trail and error, IRR = 7.75%

c.

Total cashflow in year 1 = 20*100000 = 2000000

cashflow in year 2 = 2000000*1.1 = 2200000

Cashflow in year 3 = 2200000*1.1 = 2420000

Cashflow in year 4 = 2420000*1.1 = 2662000

NPV = -7272727 + 2000000/(1+IRR)^1 + 2200000/(1+IRR)^2 + 2420000/(1+IRR)^3 + 2662000/(1+IRR)^4 = 0

By trail and error, IRR = 10%

But the required return is 12%, so the company should not produce the backpacks.

Option No.

Rate 8.25% Month(n) Cashflow (A) Discount rate = 1/(1+r)^(n) Present Value = A*discount rate 0 -620.00 1.00 -620.00 1 170.00 0.92 157.04 2 170.00 0.85 145.08 3 170.00 0.79 134.02 4 170.00 0.73 123.80 5 170.00 0.67 114.37 6 170.00 0.62 105.65 7 170.00 0.57 97.60 8 170.00 0.53 90.16 9 170.00 0.49 83.29 NPV 431.02

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