Miami 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 $5.5 million of equipment installed. The equipment would be depreciated using a 5-year accelerated depreciation schedule. Additional inventory of 10% of the first years sales would be necessary, but the entire value will be recovered at the end of the project. The firm expects to sell 420,000 units during the first year of the project, increasing to 450,000 units during the next three years before decreasing to 150,000 during the fifth and final year of the project. The product is expected to be obsolete at that point. The expected sales price is $13 per unit with a variable cost of $6 per unit during the first year of operations. Variable costs will increase by 6

% per year, but the sales price remains fixed. Fixed costs are estimated at $700,000 during the first year, but will increase by 5% per year. The firms tax rate is 21%. The equipment has an estimated salvage value of $500,000.

What is the estimated net present value of the project assuming a required return of 18%?

Management of the firm is concerned about a potential increase in the firms fixed costs and labor costs. The worst case scenario is an increase of fixed costs to $1,000,000 for each 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