You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ),

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 $1.50 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 $1.60 million on an aftertax basis. In four years, the land could be sold for $1.70 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $135,000. 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 4,800, 5,700, 6,300, and 5,200 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $750 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 believes that fixed costs for the project will be $475,000 per year, and variable costs are 10 percent of sales. The equipment necessary for production will cost $4.50 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $450,000. Net working capital of $135,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 14 percent. Refer to Table 10.7. What is the NPV of the project?

Explanation / Answer

We will begin by calculating the after tax salvage value of the equipment at the end of the project life. After Tax salvage value equals Market value of Equipment Minus Tax.

After Tax Salvage Value after 4 years= $450000-(450000*0.40)

=$270000

Now We have to Calculate the Operating Cash Flow which is calculated in the below table

Notes: Inital Spending on Capital cost and Net Working capital are cash flows at year0 whereas the Salave value at the end of the year is Cash flow at year-4. Land value at the Year-0 is Cash outflow and Market value at the end of the Project is cash inlfow.

If NPV is to be calucated then PV Factor to be Put against the Cash Flow

NPV of the project is $2032690

Year-0 Year-1 Year-2 Year-3 Year-4 Revenues $3600000 $4275000 $4725000 $3900000 Fixed Cost 475000 475000 475000 475000 Variable cost 360000 427500 472500 390000 Depreciation 1499850 2000250 666450 333450 EBIT 1265150 1372250 3111050 2701550 Taxes 506060 548900 1244420 1080620 Net Income 759090 823350 1866630 1620930 Operating Cash flow 2258940 2823600 2533080 1954380 Capital Cost -4500000 270000 Land -1600000 1700000 Net working capital -135000 135000 Total Cash Flow -6235000 2258940 2823600 2533080 4059380

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