# Net Present Value

Hello,

Could someone help me with the following problem. Thanks!

Please see the attached document.

These are the questions:

1) Using net present value computations and ignoring income taxes, analyze the one year and two year development alternatives. At this time, ignore the potential introduction of a comparable product by ACE's major competitor. Should either alternative be selected? If so, which would you recommend? ACE's cost of capital is 10 percent.

2) How would you modify your analysis in part (1) to address the potential introduction of a competing product by ACE's major competitor?

#### Solution Preview

1) The first step is to establish your discount rate. Unless other information is provided, this is usually assumed to be the cost of capital. In this case, that is 10%.

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<br>The next step is to find the net present value of the income for both scenarios. I did this in Excel, step-by-step for illustrative purposes, although you can just as easily do it all as one calculation using the NPV fuction. You would need to modify this slightly if the income was earned at the beginning of each year, or if it came in bits throughout the year, but the standard method for this type of problem is to assume that the income is earned at the end of the year.

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<br>It is also important to examine what would happen if no changes were made. This is the first case I calculated--no introduction of model Z.

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<br>Basic Scenario--Model X Only

<br>Year Income PV

<br>1 $400 $363.64

<br>2 $300 $247.93

<br>3 $200 $150.26

<br>4 $- $-

<br>5 $- $-

<br>Sum of PV income $761.83

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<br>The first option for change, introducing model Z after one year of development, yielded the following results:

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<br>Scenario 1--Introduce Z after one year

<br>Year Income PV

<br>1 $400 $363.64

<br>2 $500 $413.22

<br>3 $600 $450.79 ...