Consider a new video game developed by Dynamic Gaming, Inc. (DGI). DGI’s development team was formed at the end of 2009 and has been working on the development of the game for several years.
After spending $175,000 on the development, the team has reached the point in 2013 where it must make a decision on whether to proceed with production of the game. Production of the game will require an initial investment in facilities of $199,500 at the end of 2013. The project has an expected life cycle of 7 years (end of 2013 through 2020). Predicted cash flows for the game are as follows (assuming that all cash flows occur at the end of the year):

DGI’s applicable tax rate is 40%, and DGI uses straight-line depreciation over the asset’s expected life for tax purposes. The salvage value of the facilities will be zero in 7 years. DGI uses two criteria to evaluate potential investments: payback time and NPV. It wants a payback period of 3 years or less and an NPV greater than zero. DGI has a cost of capital of 18%.
1. Prepare a table that shows the after-tax annual net cash flows, cumulative net cash flow, and cumulative discounted net cash flow each year.
2. Would DGI invest in production of the game if it uses the payback period?
3. Would DGI invest in production of the game if it uses the NPV model?
4. Would you recommend that DGI invest in this project?Explain.

  • CreatedNovember 19, 2014
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