Cleveland Enterprises is considering the addition of a new product line. The firm would not need additional factory space, but it would require the purchase of $2.25 million of equipment installed. The equipment would be depreciated using a 7-year accelerated depreciation schedule. Additional inventory of 11% of the projected increase in next year's sales would be necessary prior to each year of operation, but the entire value will be recovered at the end of the project. The firm expects to sell 350,000 units during the first year of the project, increasing to 375,000 unites during the next three years before decreasing to 100,000 during the fifth and final year of the project. The product is expected to be obsolete at that point. The expected sales price is $12 per unit with a variable cost of $5 per unit during the first year of operations. Variable costs will increase by 5% per year, but the sales price remains fixed. Fixed costs are estimated at $600,000 during the first year, but increase 6% per year. The firm's tax rate is 25%. The equipment has an estimated salvage value of $700,000.

What is the estimated net present value of the project assuming a required return of 16%?

Management of the firm is concerned about a potential increase in the firm's fixed costs and labor costs. The worst case scenario is an increase of fixed costs to $1,000,000 in the first year due to increasing insurance costs. In addition, health insurance premiums may increase variable costs to $8 per unit. Both of these costs would increase by the percentages listed above.

What is the estimated net present value of the project assuming this potential increase in costs?

Based on your calculations, what recommendations would you make to the management of Cleveland Enterprises?