Parker Products manufactures a variey of household products. The company is considering introducing a new detergent. The

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Question:

Parker Products manufactures a variey of household products. The company is considering introducing a new detergent. The company’s financial manager has collected the following information about the proposed project. (Note: You may or may not need to use all of this information, use only the information that is relevant.)

• The project has an anticipated economic life of 4 years.

• The company will have to purchase a new machine to produce the detergent. The machine has an upfront cost (t=0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years (i.e. the company’s depreciation expense will be $500,000 in each of the first four years (t=1, 2, 3, and 4). The company anticipates that the machine will last for four years, and that after four years, it will be able to sell the machine for $500,000.

• If the company goes ahead with the proposed product, it will have an effect on the company’s net operating working capital. At the outset, t=0, inventory will increase by $140,000 and accounts payable will increase by $40,000. At t=4, the net operating working capital will be recovered after the project is completed.

• The detergent is expected to generate sales revenue of $1 million the first year (t=1), $2 million the second year (t=2), $2 million the third year (t=3), and $1 million the final year (t=4). Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue.

• The company’s interest expense each year will be $100,000.

• The new detergent is expected to reduce the after-tax cash flows of the company’s existing products by $250,000 a year (t=1, 2, 3, and 4).

• Discount rate to evaluate the project’s cash flows = 12%

• The company’s tax rate is 40%

Required: (Show all workings and formula)

Estimate the project’s cash flows. (Clearly show the answer)
Calculate the project’s Net Present Value (NPV). Should the project be accepted? Justify your answer.