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NPV and IRR Sensitivity Analysis

The chapter opener talked about Diamond Comic Distributor's attempt to reduce the cost of opening a retail comic book store. Suppose that the current cost of opening such a store is $400,000 and that $250,000 of that initial investment is the cost of stocking the shelves with new inventory. Suppose also that the annual operating cash inflow from running an average comic book store is about $62,000 before taxes and that the tax rate is 35%.

a. Assuming that the average comic book store has a life of about 10 years, what is the NPV of opening a new store if the required rate of return in this business is 10%? You may assume that the $250,000 in initial inventory will be recovered at the end of the tenth year (in addition to the annual operating cash flow for that year). What is the IRR that one can earn by opening up a new store?

b. Assume that by offering merchandise discounts to customers who are opening new stores Diamond can reduce the required initial inventory investment from $250,000 to $150,000. Maintaining all other assumptions as previously stated, how will that affect the NPV and IRR earned on a new comic book store?

Solution Summary

This solution illustrates how to perform a sensitivity analysis by changing the initial net working capital investment and subsequent recovery and the how to compute the effect of that change on net present value and internal rate of return. Additionally, it illustrates how to use Excel's NPV and IRR functions.