Jack Sparrow, owner of Black Pearl Shipping, is considering undertaking a mystical quest to the Isle of Tortuga, which will require the construction of a new ship. In deciding whether to proceed with the project, Captain Jack has accumulated the following information.

The decision to undertake the quest is to some extent based on favourable marketing research, indicating that the company's shipping sales will likely increase as a result of the quest. The research project was completed at a cost of $1 million last year.

The estimated immediate, up-front cost of constructing the new ship is $10 million. For tax purposes this ship will be part of a CCA class that depreciates assets at a rate of 15% per year. Although short of cash, the company plans to raise money for the new ship by issuing $5 million in debt at a cost of 6%, and $5 million of equity at a cost of 18%.

The company estimates the length of the quest to be 5 years, after which the ship will be sold. It estimates today that the ship's salvage value in 5 years will be $3 million.

If the ship is constructed, Black Pearl Shipping will have to increase its inventory immediately by $2 million and by an additional $1 million at the end of each of the first two years. In addition, its accounts payable will increase immediately by $1 million and by another $1.5 million in one year's time. No further changes of the company's net operating working capital requirements are expected until the end of the quest, at which time all net operating working capital increases will be recovered.

If the ship is constructed, the company's sales will increase by $7 million in the first year. However, due to high competition, these incremental sales are expected to decline by 2% each year for the remainder of the quest. It is assumed that all cash flows will occur at the end of the year.

The operating costs (excluding CCA) of the new ship are expected to be $3 million in the first year. Due to rising input costs in this sector of the economy, costs are expected to increase by 3% per year over the length of the quest. It is also assumed that these cash flows will occur at the end of each year.

The company's tax rate is 40 percent. Black Pearl's estimated cost of capital for projects of this risk is 12 percent.

Black Pearl is profitable enough to fully benefit from all CCA deductions.

Required:

Using net present value (NPV) analysis, provide a clear recommendation as to the acceptance or rejection of the proposed quest. Be careful to include only relevant costs in your analysis. Show all of your work, including formulae used with substitutions.