Vernal Communications Company is considering the production and marketing of a communications system that will increase the efficiency of messaging for small businesses or branch offices of large companies. Each unit hooked into the system is assigned a mailbox number, which can be matched to a telephone extension number, providing access to messages 24 hours a day. Up to 20 units can be hooked into the system, allowing the delivery of the same message to as many as 20 people. Personal codes can be used to make messages confidential. Furthermore, messages can be reviewed, recorded, cancelled, replied to, or deleted all during the same message playback. Indicators wired to the telephone blink whenever new messages are present. To produce this product, a $ 1.5 million investment in new equipment is required. The equipment will last 10 years but will need major maintenance costing $ 125,000 at the end of its sixth year. The salvage value of the equipment at the end of 10 years is estimated to be $ 80,000. If this new system is produced, working capital must also be increased by $ 75,000. This capital will be restored at the end of the product’s 10 year life cycle. Revenues from the sale of the product are estimated at $ 1.6 million per year. Cash operating expenses are estimated at $ 1.3 million per year.
Required:
1. Prepare a schedule of cash flows for the proposed project. (Assume that there are no income taxes.)
2. Assuming that Vernal’s cost of capital is 12 percent, compute the project’s NPV. Should the product be produced?