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Discounted Cash Flow Analysis

A sports nutrition company is examining whether a new high-performance sports drink should be added to its product line. A preliminary feasibility analysis indicated that the company would need to invest $17.5 million in a new manufacturing facility to produce and package the product. A financial analysis using sales and cost data supplied by marketing and production personnel indicated that the net cash flow (cash inflows minus cash outflows) would be $6.1 million in the first year of commercialization, $7.4 million in year two, $7.0 million in year three, and 5.5 million in year 4.

Senior company executives were undecided whether to move forward with the development of the new product. They requested that a discounted cash flow analysis be performed using two discount rates: 20 percent and 15 percent.

a. Should the company proceed with the development of the product if the discount rate is 20 percent? Why?

b. Should the company proceed with the development of the product if the discount rate is 15 percent? Why?

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