ABC Corporation manufactures a variety of electrical equipment. The company is considering introducing a radio. The companys CFO has collected the following information about the proposed product. (Note: You may or may not need to use all this information, use only the information that is relevant.)

• The project has an anticipated economic life of 5 years.
• The company will have to purchase a new machine to produce the radio. The machine has an upfront cost (t=0) of $3 million. The machine will be depreciated on a straight-line basis over 5 years (that is, the companys depreciation expense will be $600,000 in each of the five years (t=1, 2, 3, 4 and 5). The company anticipates that the machine will last for five years, and that after five years, its salvage value will equal $50,000.
• If the company goes ahead with the proposed, it will have an effect on the companys net working capital. At the outset, t=0, inventory will increase by $200,000 and accounts payable will increase by $50,000. At t=5, the net operating working capital will be recovered after the project is completed.
• The radio is expected to generate sales revenue of $2 million the first year (t=1), $2 million the second year (t=2), $3 million the third year (t=3), and $3 million the fourth year (t=4) and $2 million in the final year (t=5). Each of the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue.
• The companys interest expense each year will be $200,000.
• The new radios are expected to reduce the after-tax cash flows of the companys existing products by $200,000 a year (t=1, 2, 3, 4 and 5).
• The companys overall WACC is 12 percent. However the proposed project is riskier than the average project for ABC Corporation; the projects WACC is estimated to be 14 percent. The companys tax rate is 30 percent. Required:
  • (i) Calculate the net present value of the proposed project? (18 marks)
  • (ii) State if the project should be accepted or rejected? (2 marks)