Question

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 anticipated 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 depreciated on a straight-line basis over 4 years (that is, 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, its salvage value will equal zero.
·	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 $440,000 and accounts payable will increase by $140,000. 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 $2 million the first year (t = 1), $3 million the second year (t = 2), $4 million the third year (t = 3), and $4 million the final year (t = 4). Each year the operating costs (not including depreciation) are expected to equal 60 percent of sales revenue.
·	The company's interest expense each year will be $400,000.
·	The new detergent is expected to reduce the after-tax cash flows of the company's existing products by $200,000 a year (t = 1, 2, 3, and 4).
·	The company's overall WACC is 10 percent. However, the proposed project is riskier than the average project for Parker; the project's WACC is estimated to be 12 percent.
·	The company's tax rate is 40 percent.

Estimate the project net cash flows. Make sure to put the cash flows in order: CF0 in box 1, CF1 in Box 2, CF2 in Box 3, etc. Round it to a whole dollar, and do not include the $ sign.
In box 6 (last one), compute the project's NPV. Round it to a whole dollar, and do not include the $ sign.

Question 10 options:

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Answer 1

The cash flows and NPV are calculated as below :

Increase in net working capital = increase in inventory - increase in accounts payable

Operating cash flow (OCF) in each year = income after tax + depreciation

Cash flow in year 4 = OCF + recovery of net working capital

NPV is calculated using NPV function in Excel

NPV is $186,613