Question #74228

The HAL computer corporation is considering an increase in its annual advertising expenditure from $ 10 to $ 15 for a five-year period (i.e., in years 1 to 5). The Marketing department estimates that the increases advertising will increase profits by $ 4 in years 3 to 7 and by $ 3 in years 8 to 10 years, after which profits will return to the level they were at prior to the new program. if the firm uses a discount rate of 12 percent, will the proposes advertising program increase shareholder value ?

Expert's answer

The HAL computer corporation is considering an increase in its annual advertising expenditure from $ 10 to $ 15 for a five-year period (i.e., in years 1 to 5). The increase in advertising will increase profits by $ 4 in years 3 to 7 and by $ 3 in years 8 to 10 years. If the firm uses a discount rate of 12 percent, then the NPV of this program is:

NPV = -5/1.12 - 5/1.12^2 + (4 - 5)/1.12^3 + (4 - 5)/1.12^4 + (4 - 5)/1.12^5 + 4/1.12^6 + 4/1.12^7 + 3/1.12^8 + 3/1.12^9 + 3/1.12^10 = -$3.27.

So, the proposed advertising program will not increase shareholder value.

NPV = -5/1.12 - 5/1.12^2 + (4 - 5)/1.12^3 + (4 - 5)/1.12^4 + (4 - 5)/1.12^5 + 4/1.12^6 + 4/1.12^7 + 3/1.12^8 + 3/1.12^9 + 3/1.12^10 = -$3.27.

So, the proposed advertising program will not increase shareholder value.

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