1. You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUT
ID: 2761029 • Letter: 1
Question
1. 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 $1.49 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 $1,590,000 on an aftertax basis. In four years, the land could be sold for $1,690,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $134,000. 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 4,700, 5,600, 6,200, and 5,100 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $740 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 $470,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $4.4 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $445,000. Net working capital of $134,000 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. What is the NPV of the project?
Explanation / Answer
Calculation of outflows Sale price of land foregone now 1,590,000.00 Assuming Nil Capital Gain Tax Cost of equipment 4,400,000.00 Net Working Capital 134,000.00 Cost of Marketing research 0 (as co. has already got the research done so the cost for the research is irrelevant for NPV) Total outflows at period 0 (Now) [Q] 6,124,000.00 Calculation of inflows Year 1 Year 2 Year 3 Year 4 Units sold (a) 4,700.00 5,600.00 6,200.00 5,100.00 Price per unit (b) 740.00 740.00 740.00 740.00 A = (a) * (b) 3,478,000.00 4,144,000.00 4,588,000.00 3,774,000.00 Variable cost 15% of sales © 0.15 0.15 0.15 0.15 B = A * © 521,700.00 621,600.00 688,200.00 566,100.00 Fixed Cost [C] 470,000.00 470,000.00 470,000.00 470,000.00 Depreciation % (d) 33.33% 44.45% 14.81% 7.41% Depreciation D= 4.4 mn * (d) 1,466,520.00 1,955,800.00 651,640.00 326,040.00 Income [E= A-B-C-D] 1,019,780.00 1,096,600.00 2,778,160.00 2,411,860.00 Tax [F= E*0.40] 407,912.00 438,640.00 1,111,264.00 964,744.00 After Tax inflows [G= E-F] 611,868.00 657,960.00 1,666,896.00 1,447,116.00 Tax savings on depreciation [H] 586,608.00 782,320.00 260,656.00 130,416.00 (Depreciation * 40%) Scrap Value of Equipment [I] 445,000.00 Assuming Nil Capital Gain Tax Net working Capital recovered [J] 134,000.00 Sale of Land for Waste [K] 1,690,000.00 Total Inflows [L = G+H+I+J+K] 1,198,476.00 1,440,280.00 1,927,552.00 3,846,532.00 DCF [M] 0.884955752 0.783146683 0.693050162 0.613318728 DCF Value of inflows [N=L*M] 1,060,598.23 1,127,950.51 1,335,890.23 2,359,150.11 Total DCF Value of inflows [P] 5883589.074 NPV of the project [R= P-Q] (240,410.93) The project should not be accepted
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