Ten years ago, based on a pre-tax NPV analysis, Sante’s Sporting Goods decided to add a new product line. The data used in the analysis were as follows:
Discount rate ................. 10%
Life of product line ............... 10 years
Annual sales increase
Years 1– 4 ................. $ 115,000
Years 5– 8 ................. $ 175,000
Years 9– 10 ................. $ 100,000
Annual fixed cash costs ............. $ 20,000
Contribution margin ratio ........... 40%
Cost of production equipment ......... $ 130,000
Investment in working capital ......... $ 10,000
Salvage value ................ $ 0
Because the product line was discontinued this year, corporate managers decided to conduct a postinvestment audit to assess the accuracy of their planning process. Actual cash flows generated from the product line were found to be as follows:
Actual Investment __________________________________
Production equipment .......... $ 110,000
Working capital ............. 17,500
Total ................ $ 127,500
Actual Revenues ___________________________________
Years 1–4 ................ $ 120,000
Years 5–8 ................ 200,000
Years 9–10 .............. 103,000
Actual Fixed Cash Costs _____________________________
Years 1–4 ................ $ 15,000
Years 5–8 ................ 17,500
Years 9–10 ................. 25,000
Actual Contribution margin ratio ........ 35%
Actual Salvage value .......................... $ 6,000
Actual cost of capital ........................ 10%
a. Determine the original projected NPV on the product line investment.
b. Determine the actual NPV of the project based on the postinvestment audit.
c. Identify the factors that are most responsible for the differences between the projected NPV and the actual postinvestment audit NPV.