Initial Investment

YourCloud Pty Ltd is a cloud-based software development company located in Brisbane. The company is planning to introduce new responsive cloud based software application into the market. In recent times, the dynamic market competition has created some bad software investment decisions. Now senior management require a thorough analysis of every new product that is introduced to market. As a senior business analyst, you have been appointed to advise the senior management on the feasibility of the new product.

An initial analysis conducted by other analysts for the product claim the anticipated net present value (NPV) for the new product line is over $2 millionand they have recommended the manufacture of the product based on this assessment.

Your taskis to use a decision support system (DSS) and report to the senior management on whether the claim of the NPV being over $2 million is correct or incorrect using the relevant information given in Table 1.

Table 1: Summarised product details

Cost of production: $25.00 per unit
Annual overhead cost: $210,000 (cloud hosting is outsourced)
Initial investment needed: $1,750,000
Estimated selling price: $55.00 per unit
Market at time of introduction: 420,000 units per year
Market growth: 15% per year
Market share: Most likely 10%
Assumed economically useful lifetime: 4 years, commencing 2018
Discount rate used to analyse new product proposals is 12%

You need to assume that the overhead and initial investment occurs at the START of the respective year, profit occurs at the END of the year and initial investment was only applicable to the first year.

YOUR TASK:

  1. Develop a decision support model using Visual DSS using the variables described above. Include comments within your Visual DSS model to explain the variables and your calculations.
  2. Based on the result of your model, what is the net present value (NPV)? Explain whether the claim regarding the NPV being above $2 million is correct or incorrect.

HINTS

  • Note that overhead and initial investment both occur at the START of the respective year, and profit occurs at the END of the year.
  • You should use the correct NPV formula in Visual DSS. Use the ‘Help’ feature within the Visual DSS application and Visual DSS tutorial to learn more about the correct NPV formula, which is applicable to the scenario, described in Question 1.
  • Initial investment is a startup cost applicable to the first period only (i.e. 2018).
  • The NPV is only relevant for the first period (i.e. 2018) for decision-making – so only report it for that period. Using NPV (0) in Visual DSS will allow you to achieve this.

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