Question

I am having trouble computing the NPV for this problem (A). Can you show me the steps to take to calculate this?

Grace and Lydia met as engineering students and quickly discovered they both liked building things, gardening and most mountain sports.  As students they earned extra money helping to construct geodesic style greenhouse kits. The women worked on about a dozen of these projects and soon realized a couple of things:

• The kits were expensive
• They used all virgin materials – mostly wood and poly carbonate plastic
• Construction was slow because the triangles were small requiring more connections

As seniors they had to do a major class project so designed a greenhouse kit that was made of mostly recycled materials, was easier to construct and would be less expensive than traditional kits.  Their school had a large 3D printer that uses plastic soda and milk bottles as its inputs.  By extruding the old bottles as ribbons they could then use thermo-molding to turn them into the triangular wall pieces.  A similar process is used to create the framing struts.  They built an eight-foot diameter dome this way, so showed proof of concept.  After college they kept tinkering with the design and materials.  Finally they found some investors and started a company.  They didn’t know much about business but their investors stepped in and developed a marketing plan.  After some market research, there was still uncertainty about what consumer appeal of the product would be.  The business advisors created this table with likely high and low demand scenarios.

Year	1	2	3	4	5	6
High Demand (50%) After-tax cash flows	500,000	700,000	1,000,000	1,300,000	1,400,000	1,000,000
Low Demand (50%) After-tax cash flows	100,000	100,000	100,000	100,000	100,000	100,000
Weighted average after-tax cash flow	300,000	400,000	550,000	700,000	750,000	550,000

The equipment to make full-size greenhouse kits – 16 feet and 22 feet in diameter – would cost about $2.5 million.  If the company closes down early the after-tax cash-flow from the sale of the equipment will be $900,000 at the end of Year 1 and $650,000 at the end of Year 2.  It has no resale value beyond Year 2.

The table shows projected cash flows for high and low demand scenarios.  The cash flows include depreciation, taxes, etc.  The only thing missing is the salvage value of the equipment if the project is abandoned early.

1. Compute the traditional NPV of the project using a 10% discount rate.
2. Compute the NPV of the project using a 10% discount rate and assuming that if demand is low that the company can be shut down after Year 1 or Year 2, whichever is best.
3. Should they make this investment?
4. D.  In a very brief essay (150 words maximum) explain how the abandonment option creates value for the company.

Answer 1

The Excel calculation of all projection and the narrative explanation attached as snap.
Flow 0 Low Demand " Present value Computation @ 10% Discount Rate -2500000 -2500000 100000 90909 90909.09091 100000 82645 82644.6281 100000 75131 75131.48009 100000 68301 68301.34554 100000 62092 62092.13231 100000 56447 56447.39301 -2064474 NPV Year Weighted Avg Calculation 1 بر ارهابيا لها Flow Present value Computation @ 10% Discount Rate 0 -2500000 -2500000 113 00000 272727 272727.2727 2 400000 330579 330578.5124 3 550000 413223 413223.1405 700000 478109 478109.4188 750000 465691 465690.9923 550000 310461 310460.6615 NPV -229210 ar Flow 0 High Demand یہ اس ادای Present value Computation @ 10% Discount Rate -2500000 -2500000 500000 454545 454545.4545 700000 578512 578512.3967 1000000 751315 751314.8009 1300000 887917 887917.492 1400000 869290 869289.8523 1000000 564474 564473.9301 1606054 NPV

We will not make this investment as the Average demand of the project leads to Negative NPV of (2,29,2 10 1-), However the chances of Higher demand is very low so further considering the loss making investment we will not go ahead. If we do have the salvage value of the project then the abondeued Curly can be checked and the viability of the project can be checked at Early stage whether to go ahead on not for the project. the abondenment option can create the value for the company in knowing the opportunity cost by choosing the alternative investing options for an investment. we have calculated the NPV of the project with the projection given but the viability onder the average and low demand is in negative so its more better to avoid the investment.