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Magazine Chapter 1: Q3_11OQ (page 67)
Perot Corporation is developing a new CPU chip based on a new type of technology. Its new chip, the Patay2 chip, will take two years to develop. However, because other chip manufacturers will be able to copy the technology, it will have a market life of two years after it is introduced. Perot expects to be able to price the chip higher in the first year, and it anticipates a significant production cost reduction after the first year as well. The relevant information for developing and selling the Patay2 is given below
Patay2 Chip Product Estimates
Patay2 Chip Project Timing
a. What are this project's yearly cash flows and their present value (discounted at 10 percent)? What is the net present value?
b. Perot鈥檚 engineers have determined that spending \(10 million more on developmentwill allow them to add even more advanced features. Having a more advanced chipwill allow them to price the chip \)50 higher in both years (\(870 for year 1 and \)700for year 2). Is it worth the additional investment?
c. c. If sales are only 200,000 the first year and 100,000 the second year, would Perot stilldo the project?
Short Answer
a. The net present value will be $9,961,481.
b. Yes, it is worth the additional investment.
c. Yes, Perot still does this project.
Step by step solution
Design and product services
People, communication, and material elements must be coordinated and combined to produce high-quality service. Product design transforms ideas into tangible, useful items by fusing manufacturing expertise with product and commercial understanding.
(a) Estimating net present value
Annual cash flows, their present annual value, and the NPV (discounted at 10 percent).
The net present value is calculated as the difference between the present values of future cash inflows and outflows.
Therefore, the net present value is $9,961,481.
(b) The more advanced chip will allow them to price the chip $50 higher in both years ($870 for year one and $700 for year 2).
The net present value is 15,860,693.
Therefore, it is profitable to spend $10 million more on development if we compare the values of NPV from points b and a since NPV from points b is greater than NPV from points a.
(c)If just 200,000 in sales are made in the first year and 100,000 the next year
If the sales unit were modified to 200,000 in the first year and 100,000 in the second, the NPV value would change to $9,056. While selling 250,000 units in the first year and 150,000 units in the second, this value is significantly lower than the NPV value. Perot鈥檚 project can go on with an NPV of $9,056 since it is still enticing, albeit less so than when the sales unit was unchanged (when sales were 250,000 the first year and 150,000 the second year).
Therefore, Perot will still do this project.
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