The Baxter Company manufactures short-lived fad-type items. The R \& D Department has developed an item that would be an interesting promotional gift for office equipment dealers. Aggressive and effective efforts by Baxter's sales personnel have resulted in almost firm commitments for this product for the next three years. It is expected that demand for the product will be exhausted by that time.

In order to produce the quantity demanded, Baxter will need to buy additional machinery and rent 12,500 square feet of additional space. There is another 12,500 square feet of space adjoining the Baxter facility which Baxter will rent for 3 years at \(\$ 4\) per square foot per year if it decides to make this product.

The equipment will be purchased for about \(\$ 900,000\). It will require \(\$ 30,000\) in modification, \(\$ 60,000\) for installation, and \(\$ 90,000\) for testing; all of these activities will be done by a firm of engineers hired by Baxter. All of the expenditures will be paid for on January \(1,20 X X\).

The equipment should have a salvage of about \(\$ 180,000\) at the end of the third year. No additional general overhead costs are expected to be incurred.

The following estimates of revenues and expenses for this product for the three years have been developed:

{Required:}
(1) A schedule showing the net increase in aftertax cash inflow for this project.
(2) A decision (with supporting computations) as to whether this project should be untaken if the Baxter Company requires a two-year payback period for its investment.
(3) The after-tax average annual return on average investment for the project.
(4) A decision (with supporting computations) as to whether the project will be accepted if the company sets a required 20 percent aftertax rate of return. (A newly hired business school graduate recommends that the Baxter Company consider using net present value analysis to evaluate this project.)

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Sales..... Material, labor, and additional factory overhead.. Assigned general overhead........... Rent (12,500 square feet of space x $4).. Depreciation. Total expenses. Net income before income tax. Income tax (10%)... Net income 20XX $1,000,000 20XY $1,600,000 20XZ $800,000 $ 400,000 $ 750,000 $350,000 77,500 112,500 72,500 50,000 50,000 50,000 450,000 300,000 150,000 $ 977,500 $1,212,500 $622,500 $ 22,500 $ 387,500 $177,500 9,000 155,000 71,000 13,500 $ 232,500 $106,500