Dwayne Security Network Ltd$.($DSN$)$ is a producer of many alarm systems including, fire alarms, home, and personal security systems. $($DSN$)$ has already invested $$1\mathrm{.}8$ million dollars into research and development connected with the design and production of a new super$-$security system involving highresolution surveillance cameras. DSN is now considered a leader in the field. DSN believes that the competitive advantage, by bringing this product to market now, will last $5$ years. The vice president in charge of finance has provided you with the following data and worksheet and asked you to determine, using an NPV analysis, if the new product should be brought to the market. She has also hinted that your future with the company hinges on a successful analysis of the project.

Data Sheet:

Company's effective tax rate $=32\%$

Company's cost of capital $=15\%$

Inventory worth $$600,000$ must be established immediately. Inventories each year will rise by

$$200,000$ in each of the first $2$ years of the project, at which time it will level out until the end of year $4$ and then drop $$200,000$ for the duration of the project. Cash must also be available. Cash requirements in each year of the project if it is accepted, are:

Year $0$$$0$

Year $1$$$0$

Year $2$$$100,000$

Year $3$$$100,000$

Year $4$$$400,000$

Year $5$$$0$

DSN already has an existing $10-$year lease on a vacant building, and there are five years remaining on this lease. The lease expenses are $$600,000$ per year payable in advance. If they decide to go ahead, DSN will have to invest an additional $$10,000,000$ in production facilities immediately which they can install in the leased building. DSN expects to be able to sell the machinery to a competitor after the five years for $$1,800,000.$ This new machinery will be on a $5-$year schedule according to the MACRS table.

DSN has decided to set its selling price at $$2,000$ per surveillance package and has estimated the firstyear market share to be $2,000$ packages. It further believes that this market share will shrink by $5\%$ per year for each of the remaining years of competitive advantage as competitors enter the market.

Operating expenses associated with the project are estimated to be $$1,000,000$ in the first year of the project. These are expected to remain constant for the next $5$ years. Assume that these cashflows occur at the end of each of the five years. DSN estimates that introducing these new surveillance cameras to the market will result in an increase in net sales $($i$.$e$.,$ sales minus variable costs$)$ of their existing products by $$250,000$ in the first year of the project and that this increase will grow at $1\%$ per year indefinitely. Assume that this cash$-$flow occurs at the end of each year. At the end of the five$-$year period DSN will have to restore the building to its original condition. If they proceed with the project this will cost $$1,000,000$; otherwise, it will cost $$100,000.$

a$)$ What is the impact on the NPV of the project of the

$$1,800,000$ research and development costs?

b$)$ What is the impact on the NPV of the project of the $10-$year lease on the building? $(1$ mark$)$

c$)$ What is the impact on the NPV of the project of the $$10$ million investment in new equipment?

$($Ignore the effect of any possible tax shields and salvage.$)(1$ mark$)$

d$)$ What is the impact on the NPV of the project of the net working capital investment. $(3$ marks$)$

e$)$ What is the impact on the NPV of the project of the tax shields associated with the use of the assets in the project? $(3$ marks$)$

f$)$ What is the impact on the NPV of the project of the salvage of the assets at the end of year five?

$($Ignore the effect of any lost tax shields.$)(2$ marks$)$

g$)$ What is the impact on the NPV of the project of the incremental revenues associated with the project $($excluding increased sales of other products?$)(2\mathrm{.}5$ marks$)$

h$)$ What is the impact on the NPV of the project of the incremental expenses associated with the

project $($excluding increased sales of other products?$)(2$ marks$)$ i$)$ What is the impact on the NPV of the project of the increased sales of DSN$\text{'}$s other products? $(2$

marks$)$

j$)$ What is the impact on the NPV of the project of the restoration of the building? $(2$ marks$)$

k$)$ What is the NPV of the project & what is your recommendation? $(0\mathrm{.}5$ mark$)$

$NPV=$ therefore, the project