NPV
We can compute a net present value for each project to decide which project creates more value. First, we need to figure out the initial cash outflow of each project. Table 1 and table 2 illustrate the initial cash outflows of MMDCL and DYOD separately. As the upfront R&D and marketing are tax deductible and the tax rate is 40%, the initial expenditures are $3.02 million and $5.331 millions. Next step is to calculate the unlevered cash flows of each year. As the result 9.2 (p.310) illustrates, unlevered cash flow = profit before interest and taxes + depreciation and amortization – change in working capital – capital expenditures + sales of capital assets – realized capital gains + realized capital losses – profit before interest and taxed * tax rate.The process of computing the working capital from year 2010 to 2020 was explained in Table 3 and Table 4. The computation of the unlevered cash flows for each project was illustrated in Table 5. As the case pointed out, project MMDCL entailed moderate risk, which is 8.4%, while project DYOD revealed a relatively high risk, which is 9%. In addition, both projects can create indefinitely value if it is given continuing investment. As a consequence, when calculate the net present value; we have to regard it as a growing perpetuity. The U.S. retail sales of dolls were planed to grow at a constant rate by 3% per year. To persuade a conservative projection, we used a relatively low perpetual growth rate, which is 2% in this case.
Therefore, we can compute each project’s NPV separately:
NPV$5,973,830; NPV$5,376,220
Although both projects have similar positive NPVs, those can be accepted. However, as these two projects are mutually exclusive, so we should accept project MMDCL, which has the highest NPV to creates more value for the company and reject project DYOD.
IRR
We can also evaluate the two projects using