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 $1.39 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 $1,490,000 on an aftertax basis. In four years, the land could be sold for $1,590,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $124,000. 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 3,700, 4,600, 5,200, and 4,100 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $640 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 $420,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $3.4 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $395,000. Net working capital of $124,000 will be required immediately and will be recaptured at the end of the project. PUTZ has a 35 percent tax rate, and the required return on the project is 12 percent. Assume the company has other profitable projects. What is the NPV of the project? (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Computation of NPV of the project is as follows: Particulars Year Cash flow discount rate @12% Discounted cash flows Project cost 0 -3400000 1 -3400000 Net working capital -124000 Cash flows 1 1354987 0.8928 1209732.394 2 1786835 0.7971 1424286.179 3 1633799 0.7117 1162774.748 4 1698659 0.6355 1079497.795 Net present value 1352291.115 Workings Computation of cash flows Year 1 Year 2 Year 3 Year 4 Units 3700 4600 5200 4100 Rate 640 640 640 640 Sales 2368000 2944000 3328000 2624000 Less: Variabe costs at 20% 473600 588800 665600 524800 Fixed costs 420000 420000 420000 420000 Depreciation 1133220 1511300 503540 251940 Income 341180 423900 1738860 1427260 Less: Tax @35% 119413 148365 608601 499541 Net income 221767 275535 1130259 927719 Add: Depreciation 1133220 1511300 503540 251940 Cash flows 1354987 1786835 1633799 1179659 Add: Scrap of equipment 395000 Net working capital 124000 1698659 Computation of depreciation Year 1 Year 2 Year 3 Year 4 Depreciable value 3400000 3400000 3400000 3400000 Rate of depreciation @ half year convention 33% 44% 14.81% 7.41% 1133220 1511300 503540 251940 Total

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