13. In your new role as the Chief Financial Officer of Clean Water Solutions Co, it is your responsibility to oversee a new water filtration project that is expected to last the next 10 years. The company is considering investing in a new water filter for refrigerators that will be priced at $65 each, while variable costs for producing each filter are $22. Initial estimates suggest that the company will sell 800,000 units in the projects first year, and the number of units sold is expected to increase by 20,000 units annually. The selling price per unit is expected to decrease by $3 per year due to the release of newer versions. Variable costs per unit are also expected to decrease annually due to efficiency gains in the production process. Estimates suggest that variable costs will decrease by $0.75 per year.

Fixed costs for the project are expected to be $5 million per year. There will also be a $7.5 million investment in net working capital. 100% of this investment will be recouped in the projects final year. Moreover, the company will need to invest a total of $125 million in fixed assets. Clean Water Solutions Co. uses two forms of depreciation for its fixed assets. The company uses straight-line depreciation on its income statements, which assumes that the fixed assets have a pre-tax salvage value of $3 million. Meanwhile, the company uses the Modified Accelerated Cost Recovery System (MACRS) for tax purposes when determining the tax implications on the sale of its fixed assets. Assume that the fixed assets are classified as 10-year property under MACRS: Depreciation Year 10-Year MACRS

Year 1 10.00%

Year 2 18.00%

Year 3 14.40%

Year 4 11.52%

Year 5 9.22%

Year 6 7.37%

Year 7 6.55%

Year 8 6.55%

Year 9 6.56%

Year 10 6.55%

Year 11 3.28%

You have also collected the following information:

The firm has 1 million shares of common stock outstanding, 300,000 shares of preferred stock outstanding, and 150,000 bonds outstanding. The common stock is trading for $116 per share; the preferred stock is trading for $93 per share; and the bonds are trading for 91.8 percent of face value.

The risk-free rate of return is 3.05 percent; the firms beta is 1.25; and the expected market risk premium is 8.40 percent.

The outstanding bonds each have a face value of $1,000, mature in 13.5 years, have a coupon rate of 4.5 percent, and pay interest semi-annually.

The preferred stock has a face value of $100 each and pays an annual dividend of $6.35.

Finally, assume the corporate tax rate is 21 percent.

What is the net present value of this project? Should it be accepted or rejected based on the net present value? (25 points)

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