The HTT Company is considering a new product. The new product has a five-year life. Sales and net income after taxes for the new product are estimated in the following table:
The equipment to produce the new product costs $500,000. The $500,000 would be borrowed at a risk-free interest rate of 14 percent. However, the machine adds only $300,000 to the firm's debt capacity in years 1, 2, and 3, and only $200,000 in years 4 and 5. Although net income includes the depreciation deduction, it does not include the interest deduction (that is, it assumes that the equipment is financed with equity). The equipment can be depreciated on a straight-line basis over a five-year life at $100,000 per year. The equipment is expected to be sold for $100,000 in five years. Net working capital (NWC) required to support the new product is estimated to be equal to 10 percent of net sales of the new product. The NWC will be needed at the start of the year. This means that if sales were $1 in year 1, the NWC needed to support this one dollar of sales would be committed at the beginning of year 1. The company's discount rate for the unlevered cash flows associated with this new product is 18 percent and the tax rate is 40 percent. What is the net present value of this project?