Problem-2 (Net present value analysis – handling working capital)

The Universal Trading Company has obtained a license to introduce a new product for 6 years. The product would be purchased from manufacturing company for $10 per unit and sold to customers for $20 per unit. The estimated annual cash expenses to sell the new product would be $18,000. Other information associated with the new product is given below:

  • Cost of equipment needed: $30,000
  • Working capital needed: $40,000
  • Repairs and maintenance of equipment after 5 years: $2,500
  • Residual value of equipment after 6 years: $5,000

The working capital would be released at the end of 6-year period. The expected annual sales are 5,000 units of product. The discount rate of the company is 16%.

Required:

  1. Compute net present value (NPV) of the new product. (Ignore income tax).
  2. Would you recommend the addition of new product?

Solution:

(1) Net present value (NPV) of new product:

problem-2-cbt-img1

*Value from “present value of an annuity of $1 in arrears table“.
**Value from “present value of $1 table”.

(2) Conclusion:

Yes, the addition of new product is recommended because its net present value (NPV) is positive.

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4 Comments on Problem-2 (Net present value analysis – handling working capital)

  1. Petrus Navus

    Most grateful.. this information makes my job as a new lecturer in agriculture management most rewarding.
    Would you be able to send me an e-copy of the topic please.

    Thank you in advance!!

    Peter

  2. TAFADZWA TSURO

    THANK YOU BUT HOW DO TREAT WORKING CAPITAL
    TYHANK YOU

  3. TAFADZWA TSURO

    thank you but how do incoorporate working capital in NPV

  4. Muhammad

    Where’s the depreciation computation?

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