Problem: Parker Products manufactures a variety of household products. The company is considering introducing a new detergent. The company’s CFO has collected the following information about the proposed product. (Note: You may or may not need to use all of this information, use only the information that is relevant.)
The project has an expected economic life of 4 years.
The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be fully depreciated using the straight-line method over 4 years. The company expects that the machine will last for four years, and that after four years, its salvage value will equivalent zero.
If the company goes ahead with the proposed product, it will have the effect on the company’s net operating working capital. At the outset, t = 0, inventory will raise by $140,000 and accounts payable will rise by $40,000. At t = 4, the net operating working capital will be recovered after the project is completed.
The detergent is anticipated 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 comprising depreciation) are expected to equivalent 50 percent of sales revenue.
The company’s interest expense each year will be $100,000.
The new detergent is anticipated to reduce the after-tax cash flows of the company’s existing products by $250,000 a year (t = 1, 2, 3, and 4).
The project’s discount rate is estimated to be 12 percent. The company’s tax rate is 40 percent.
What is the NPV of the proposed project?