You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost $900,000 to develop up front (year 0), and you expect revenues the first year of $790,000 , growing to $1.43 million the second year, and then declining by 45% per year for the next 3 years before the product is fully obsolete. In years 1 through 5, you will have fixed costs associated with the product of $91,000 per year, and variable costs equal to 50% of revenues.

a. What are the cash flows for the project in years 0 through 5?

b. Plot the NPV profile for this investment using discount rates from 0% to 40% in 10% increments.

c. What is the project's NPV if the project's cost of capital is 10.3% ?

d. Use the NPV profile to estimate the cost of capital at which the project would become unprofitable; that is, estimate the project's IRR.

Question

Business

Blake Hammond

18 February, 17:20

You are CEO of Rivet Networks, maker of ultra-high performance network cards for gaming computers, and you are considering whether to launch a new product. The product, the Killer X3000, will cost $900,000 to develop up front (year 0), and you expect revenues the first year of $790,000 , growing to $1.43 million the second year, and then declining by 45% per year for the next 3 years before the product is fully obsolete. In years 1 through 5, you will have fixed costs associated with the product of $91,000 per year, and variable costs equal to 50% of revenues.

a. What are the cash flows for the project in years 0 through 5?

b. Plot the NPV profile for this investment using discount rates from 0% to 40% in 10% increments.

c. What is the project's NPV if the project's cost of capital is 10.3% ?

d. Use the NPV profile to estimate the cost of capital at which the project would become unprofitable; that is, estimate the project's IRR.

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Answers (1)

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Ronin Ward · Answer 1

A)

year cash inflows cash outflows net cash flows

0 0 - 900,000 - 900,000

1 790,000 - 486,000 304,000

2 1,430,000 - 806,000 624,000

3 786,500 - 484,250 302,250

4 432,575 - 307,288 125,287

5 68,908 - 125,454 - 56,546

B)

NPV 0% discount rate = $398,991

NPV 10% discount rate = $169,613

NPV 20% discount rate = - $725

NPV 30% discount rate = - $130,712

NPV 40% discount rate = - $232,241

C)

NPV 10.3% discount rate = $163,760

D)

almost 20%, since the IRR is the discount rate where NPV = $0

Actual IRR = 19.95%