Reference no: EM131586381

Michael Products manufactures a variety of household products. Two years ago, they conducted a marketing study to collect consumers’ perception about detergents existing in the market. The study cost them $1,000,000. Today, the company is considering introducing a new detergent: clean-it-all. The company’s CFO Michael has collected the following information about the proposed product. The project has an anticipated economic life of 4 years, after that it will not be continued and will be terminated. The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years (that is, the company’s depreciation expense will be $500,000 in each of the first four years (t = 1, 2, 3, and 4). The company anticipates that the machine will last for four years, and that after four years, its salvage value will equal zero. If the company goes ahead with the proposed product, it will have an effect on the company’s operating working capital. At the outset, t = 0, inventory will increase by $140,000 and accounts payable will increase by $40,000. The detergent is expected to generate sales revenue of $1 million the first year (t = 1), $2 million the second year (t = 2), $2 million the third year (t = 3), and $1 million the final year (t = 4). Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue. The company’s interest expense each year will be $100,000. The new detergent is expected to reduce the after-tax cash flows of the company’s existing products by $250,000 a year (t = 1, 2, 3, and 4). The company’s overall cost of capital is 12 percent. The company’s tax rate is 40 percent. Should this company produce the new detergent? (Show detailed cash flows and NPV calculations)