Reference no: EM132472321
Point 1: You are considering two possible projects (Project A and Project B) that would start at the beginning of 2020. Your boss has indicated that she only wants to select one of these projects given resource constraints and uncertainties about the economy. She has asked you to evaluate each project and recommend which project you think the company should select.
Point 2: You have made the following forecasts for each project. Project A would require an initial investment of $6.4M (USD) on January 1, 2020 and a second investment of $4M on Jan 1, 2021. The project would break even in the following year (2022) but would earn positive returns of $1.2M, $3.5M, $7.1M, and $12.6M in the following four years.
Point 3: Project B would require an initial investment of $18M on January 1, 2020 but would not earn (or cost) anything until the end of 2024 when you think it would return approximately $45M.
Point 4: You estimate that an appropriate annual discount rate is 14 percent based on your company's future projected performance. Furthermore, the CFO has indicated that there is an inflation rate of 2.5 percent that should be factored into your calculations; he feels that this rate will be fairly constant over the foreseeable future. The CFO has also indicated that the company uses discrete discounting and assumes that all cash flows occur at the end of each year (except for the initial investments).
Point 5: Your boss indicated that you should consider the inflation rate adjusted NPV, the IRR, and the Profitability Index when comparing these two projects. Based on these metrics, which project would you recommend? What other factors (other than these metrics) might be important when comparing these projects? How would your company's risk tolerance impact the possible decision?
Question 1: Assume that you have successfully completed the R&D phase of a new product development project; this phase took several years and cost an estimated $14.75 million but resulted in a successful prototype product. You and your company are now ready to start the market development and research phase of your new product development project. It is estimated that the market development and research phase of this project will take two years and cost $11.5M per year. There is an eighty percent probability that the market development and research phase will indicate that a viable market exists for your new product.
Point 6: Before your company can begin the market development and research phase, however, a long-time rival announced that it plans to market a similar product in one year that will directly compete with your newly developed product. Your company feels that there is a 60 percent probability that your new product will be superior to your competitor's product.
Point 7: If your company's product is superior to your competitor's product and the market development phase indicates that a viable market exists, you will earn a net profit of $10 million per year for ten years. If your product is inferior to your competitor's product, you will terminate the project. Assuming a discount rate of 14 percent, calculate the expected NPV of your new product assuming that you proceed immediately with the marketing development and research phase.
Point 8: In analyzing this problem, you should make the following assumptions. First, if you learn that your competitor's product is better than your product after one year of market development, you will terminate the project and not incur the market development cost ($11.5M) for the second year. Second, assume that all cash flows occur at the end of the year.
Question 2: Compare your results to the case when you decide to wait for one year (to learn more about your competitor's product) before proceeding with the market development and research phase. If you postpone the market development phase by a year, however, and your product is superior to your competitor's project (and a viable market exists), it will only have a nine year life span. What do you think is your best strategy? Why?