InstruChem manufactures chemical cleaning products. Due to recent environmental protection requirements, InstruChem must now improve the final disposition of its chemical by-products. These requirements will increase R&D costs, which are needed to develop the most efficient process to dispose of the by-product and will add new disposition costs when the regulations come into full effect in 2 years. The accountants have estimated five years of information for the product as follows:

InstruChem pays an income tax rate of 20% and has income from other products to offset any initial losses. The project has a required rate of return of 7%.

Required:

A. Determine the net present value (NPV) of the cash flows of the project over the estimated five years of its life cycle.

B. In performing sensitivity analysis, which factors would you vary? Explain.

C. Would you recommend that InstruChem undertake the project? Explain.

D. What other qualitative factors would you consider when analyzing this project?

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Year 1 Year 2 Year 3 Year 4 Year 5 Litres manufactured and sold 50,000 50,000 65,000 65,000 65,000 $ 15.00 $ 5.00 $ 15.00 $ 16.50 $ 16.50 $ 5.00 $ 5.50 $ 5.50 Selling price per litre $ 16.50 Variable costs per litre $5.50 $150,000 $150,000 $150,000 $150,.000 $ 10,000 $ 50,000 Fixed costs $150,000 $ 10,000 $ 35,000 R&D costs $250,000 $250,000 $100,000 Disposition costs $ 10,000 $ 10,000 $100,000