New Futuristics Company is thinking about marketing a new software product. Upfront costs to market and develop the product are $10 million. Starting in year 1, the product is expected to generate Free Cash Flows of $1.5 million per year for 15 years. The company will have to provide product support expected to cost $200,000 per year in perpetuity, which have not been included in the FCF just mentioned. Assume all cash flows (except for the upfront costs) occur at the end of each year.
(a) What is the net present value (NPV) of this investment if the cost of capital is 5%? Should the firm undertake the project?
(b) Repeat the analysis for discount rates of 1% and 15%. Should the company undertake the project in these two cases?
(c) What is the payback period of the project? (Note: You only need to consider the upfront costs in this calculation)
(d) How many IRRs does this investment opportunity have? (Hint: Plot the project NPV as a function of the discount rate, i.e. creating a graph which shows what the NPV is for a broad range of discount rates)
(e) Can the IRR rule be used to evaluate this investment? Explain.