Scenario Question

It is the beginning of 2001. Sony has decided to introduce a new video game system called the Sony PS2. The system will sell for $140. Demand is forecast at 2.5 million units per year for four years (2001, 2002, 2003, 2004) but a particularly insightful economic analyst suggests that demand will fall by 30 percent each year in the following two years (2005 and 2006).

For each system sold, 10 game cartridges will be sold at a price of $20 per cartridge. The system has a variable cost of $40 and each game cartridge has a variable cost of $4. Fixed costs are $8 million per year, including advertising spending.

The equipment used to manufacture the PS2 has a cost of $4 million and will be depreciated on a straight-line basis over the period of six years. The taxation rate is 30 percent. The relevant discount rate is 18 percent. Calculate the NPV of the Sony PS2 and advise whether the project should be undertaken.

The initial cost = 4 million.

Find the net present value (NPV) of the project?

Based on NPV, would you accept or reject the project?