You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ),
ID: 2737425 • Letter: Y
Question
You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1.46 million in anticipation of using it as a toxic waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $1,560,000 on an aftertax basis. In four years, the land could be sold for $1,660,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $131,000. An excerpt of the marketing report is as follows: The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 4,400, 5,300, 5,900, and 4,800 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $710 can be charged for each zither. Because zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued. PUTZ feels that fixed costs for the project will be $455,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $4.1 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $430,000. Net working capital of $131,000 will be required immediately and will be recaptured at the end of the project. PUTZ has a 40 percent tax rate, and the required return on the project is 13 percent. Assume the company has other profitable projects. Table 8.3. What is the NPV of the project?
Explanation / Answer
Discount rate Wacc 13.00% TaxRate TaxRate 40% 0 1 2 3 4 Land L 15,60,000 Plant&equipment E 41,00,000 Investment Investment=E+L 56,60,000 Total Sales new units sold per year n 4,400 5,300 5,900 4,800 Price of unit p 710 710 710 710 Total $Sales units sold per year S=n*p 31,24,000 37,63,000 41,89,000 34,08,000 Fixed Costs/year f 4,55,000 4,55,000 4,55,000 4,55,000 Total Variable costs/year VC 4,68,600 5,64,450 6,28,350 5,11,200 MACRS rate rate 33.33% 44.45% 14.81% 7.41% Depreciation d=E*rate 13,66,530 18,22,450 6,07,210 3,03,810 EBIT EBIT=S-f-VC-d 8,33,870 9,21,100 24,98,440 21,37,990 Working Capital NWcInv 1,31,000 1,31,000 1,31,000 1,31,000 1,31,000 chg in WorkingCapital w=NWcInv(t+1)-NWcInv(t) 0 0 0 0 AnnualOperatingCashFlows(OCF) OCF=EBIT*(1-TaxRate)+d-w 18,66,852 23,75,110 21,06,274 15,86,604 SalvageValue MV 4,30,000 Book Value (BV=Equipment Cost-Total Depreciation) 41,00,000 27,33,470 9,11,020 3,03,810 0 After tax SalvageValue MV-TaxRate*(MV-BV in yr 4) 2,58,000 TerminalCF (=After tax MV+NWcInv+1,660,000)=CFT 20,49,000 Initial Outlay (=-(Investment+NWcInv))=CFi -57,91,000 Net CashFlows/year, CF=OCF+CFT+CFi -57,91,000 18,66,852 23,75,110 21,06,274 36,35,604 PV of Cash Flows PV=CF/(1+Wacc)^t -57,91,000 16,52,081 18,60,060 14,59,754 22,29,784 PV Present Value of Future Cash Flows yr 1-4 $ 72,01,678.49 NPV (=PV+Cash Flow in year0) $ 14,10,678.49
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