A Manufacturing Company Is Thinking of Launching a New Product. the Company Expects to Sell $950,000 of the New Product in the First Year and $1,500,000 Each Year Thereafter. Direct Costs Will Be 45% of Sales. Indirect

677 Words Aug 26th, 2014 3 Pages
Payback and NPV

Tiffanie Lampley
FINA 310, Unit 4 IP
AIU
Instructor Morales
December 8, 2013

Abstract This essay includes projected cash flows for the next eight years. The payback period method is used to determine the amount of time it would take the company to recoup initial investment costs. The net present value is then tabulated in order to determine whether the project should be rejected or accepted.

Payback and NPV A manufacturing company is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 45% of sales. Indirect incremental costs are estimated at $95,000 a
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Using the subsequent investment balance of $1,422,125 divided by the annual net cash flows of $474,500 yields a payback period of 3 additional years for a total of four years to pay off initial investment. The company automatically rejects all projects with a payback period over three years, therefore based only on this criteria the project would be rejected. However, the net present value method can also be utilized to determine if the company should undertake the project or not. The net present value is based on the calculation of present value. Present value is calculated by dividing the annual cash flow by the capital rate (10%) plus one raised to the power of the year calculated. So for the first year the equation looks like this: PV=277,875/(1+0.10)^1. Then:
Year 2:PV= 474,500/1.10^2 or 474,500/1.21
Year 3: PV=474,500/1.10^3 or 474,500/1.331
Year 4: PV= 474,500/1.10^4 or 474,500/1.4641
Year 5: PV= 474,500/1.10^5 or 474,500/1.61051
Year 6: PV= 474,500/1.10^6 or 474,500/1.771561
Year 7: PV= 474,500/1.10^7 or 474,500/1.9487171
Year 8: PV= 474,500/1.10^8 or 474,500/2.1435888
The net present value is equal to the above totals after calculation. These figures are given in the above table. The net present value is equivalent to $2,352,672.44 minus the

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