Risk and Financial Management $M$

Question $2$

A company is seeking to justify a new product development that takes place in two phases: the first

phase involves designing and building a prototype for testing, launching into manufacture and then

selling products to establish the market position. The second phase is then to develop additional

features in the product that will reinforce market position and beat down competition. The following

is the schedule of costs and income expected, in today's value:

Cost of development and testing the prototype, spread equally over two years: $1400k$

The company has an internal rate of return $($hurdle rate$)$ of $9\%$ for such projects.

a$).$ Carry out a discounted cash forecast and identify the net present value of this project after

the $7^{th}$ year of sales. Is it justified?

$70\%$

b$).$ Using an approximate interpolation method, estimate the actual rate of return of this

project after the $7$ years of sales.