Life-Cycle Budgeting. Will O'Connell, product development director of WM Labs, is meeting with the research, marketing, and finance directors tomorrow. His staff has brought together pieces of a financial puzzle on a potential new product. The research lab has spent \(\$ 100,000\) last year (1996) and \(\$ 300,000\) this year (1997) on a project that looks promising. The product, apparently environmentally safe, would cause ground moles to pack their bags and move on. Will's projections show a huge market and strong profits if final testing and production problems can be solved. The research lab forecasts continuing development costs of \(\$ 500,000\) next year (1998) and \(\$ 300,000\) in 1999. Production engineering costs will start in 1998 at \(\$ 200,000\) and continue in 1999 at \(\$ 400,000\). Equipment costs for production would be \(\$ 2,000,000\), incurred at the end of 1998 and depreciated over the next five years using straight-line depreciation.

The product will be introduced in 1999 with annual sales projected at \(\$ 800,000\), \(\$ 3,000,000, \$ 5,000,000, \$ 4,000,000\), and \(\$ 3,000,000\) through 2003 , respectively. Cash production costs as a percentage of sales are expected to be \(60,55,50,40\), and 40 percent through 2003, respectively. After an initial advertising campaign of \(\$ 300,000\) per year in 1999 and 2000, advertising expenses should be \(\$ 200,000\) per year. Will's reports show possible international licensing arrangements. Licensing fees would be 5 percent of international sales. Will thinks international sales will parallel U. S. domestic sales but will lag by one year and cease in 2003. Assume all cash flows occur at yearend. The tax rate is 40 percent.

\section*{Required:}

1. Comment on the role of 1996 and 1997 expenditures in the project's analysis.

2. Prepare a product life-cycle project analysis showing cumulative expected cash flows through 2003.

3. Evaluate the project for capital investment purposes if WM Labs uses a 15 percent hurdle rate.

4. Comment on the impact of the discount rate on this project.