A firm is trying to determine which of two products it should launch. Product A has an expected life of three years. It will bring in cash flows of $10,000 in each of the three years. Product B has an expected life of two years. It will bring in cash flows of $15,000 in each of the two years. Assume a discount rate of 8%. Which product should the firm, based on NPV alone, select?
A) Product A
B) Product B
C) Product A and B are equivalent
D) NPV for the products cannot be calculated with the information given.

Question

Quizplus · Accepted Answer

To determine the NPV for each product, we need to calculate the present value of the cash flows and subtract the initial investment.

For Product A: 
PV of cash flows = $10,000/(1+0.08)^1 + $10,000/(1+0.08)^2 + $10,000/(1+0.08)^3 = $26,247.91 
NPV = $26,247.91 - initial investment (not given)

For Product B: 
PV of cash flows = $15,000/(1+0.08)^1 + $15,000/(1+0.08)^2 = $27,333.33 
NPV = $27,333.33 - initial investment (not given)

Since Product B has a higher NPV than Product A, the firm should select Product B.

A Firm Is Trying to Determine Which of Two Products