Home Publications Inc. is considering two new magazine products. The estimated n

Question

Home Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follows:

Each product requires an investment of $280,000. A rate of 15% has been selected for the net present value analysis.

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1a. Compute the cash payback period for each product.

                                                  Cash Payback Period
Home & Garden

1 year or 2 years or 3 years or 4 years or 5 years

Music Beat

1 year or 2 years or 3 years or 4 years or5 years

1b. Compute the net present value. Use the present value of $1 table above. If required, round to the nearest dollar.

                                                               Home & Garden                                Music Beat
Present value of net cash flow total                  $                                                      $
Less amount to be invested                             $                                                     $
Net present value                                             $                                                      $

2. Because of the timing of the receipt of the net cash flows, the home & garden or music beat magazine expansion offers a higher net present value or net cash flow

.

Year Home & Garden Music Beat 1 $154,000 $129,000 2 126,000 151,000 3 109,000 104,000 4 98,000 73,000 5 31,000 61,000 Total $518,000 $518,000

Each product requires an investment of $280,000. A rate of 15% has been selected for the net present value analysis.

Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 0.890 0.826 0.797 0.756 0.694 3 0.840 0.751 0.712 0.658 0.579 4 0.792 0.683 0.636 0.572 0.482 5 0.747 0.621 0.567 0.497 0.402 6 0.705 0.564 0.507 0.432 0.335 7 0.665 0.513 0.452 0.376 0.279 8 0.627 0.467 0.404 0.327 0.233 9 0.592 0.424 0.361 0.284 0.194 10 0.558 0.386 0.322 0.247

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Explanation / Answer

(a) Home and garden - (i) NPV = Years 0 1 2 3 4 5 Initial investment -280000 Cash flows 154000 126000 109000 98000 31000 Total cash flows -280000 154000 126000 109000 98000 31000 PV factors 1 0.869565 0.756144 0.657516 0.571753 0.497177 PV of cash flows -280000 133913 95274.1 71669.27 56031.82 15412.48 NPV = 92300.71 (ii) Payback period = Year cash flows Cumulative cash flows 0 -280000 0 1 154000 154000 2 126000 280000 3 109000 389000 4 98000 487000 5 31000 518000 Payback period = 2 i.e. where the cumulative cash flows are equal to initial investments (b) Music beats - (i) NPV = Years 0 1 2 3 4 5 Initial investment -280000 Cash flows 129000 151000 104000 73000 61000 Total cash flows -280000 129000 151000 104000 73000 61000 PV factors 1 0.869565 0.756144 0.657516 0.571753 0.497177 PV of cash flows -280000 112173.9 114177.7 68381.69 41737.99 30327.78 NPV = 86799.06 (ii) Payback period = Year cash flows Cumulative cash flows 0 -280000 0 1 129000 129000 2 151000 280000 3 104000 384000 4 73000 457000 5 61000 518000 Payback period = 2 i.e. where the cumulative cash flows are equal to initial investments (c ) Decision - Criteria Home and garden Music beats Remarks NPV (Higher) 92300.71 86799.06 Music beats (Higher NPV) Payback Period (Lower) 2.2 Years 2.5 Years Home and garden (Lower Payback) Home and garden has higher net cash flows or NPV Please provide feedback……... thanks in advance……… :-)

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