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 $1.32 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 $1,420,000 on an aftertax basis. In four years, the land could be sold for $1,520,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $117,000. 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 3,000, 3,900, 4,500, and 3,400 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $570 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 $385,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $2.70 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $360,000. Net working capital of $117,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 13 percent. Assume the company has other profitable projects. MACRS schedule. 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

Year0 Year 1 Year2 Year3 Year4 Unit Sold [a] 3000 3900 4500 3400 Unit Price [b] 570 570 570 570 Sales [ c = a*b] 1710000 2223000 2565000 1938000 Variable Cost [ d = 15%*c] 256500 333450 384750 290700 Fixed Cost [e] 385000 385000 385000 385000 Depreciation [f] 128320.5 171133 57018.5 28528.5 Net Operating Income before tax [g = c-d-e-f] 940179.5 1333418 1738232 1233772 Tax Expenses [h = g*40%] 376071.8 533367 695293 493509 Annual Operating cash flow [i= g+f - h] 692428.2 971183 1099957 768791 Land [j] -1420000 1520000 Equipment Cost [k] -2700000 216000 Net Working Capital used & realised [l] -117000 117000 Post Tax Salvage Value [m] Cash flow [n] -4237000 692428.2 971183 1099957 2621791 PV Factor @ 13% [o] 1 0.88495575 0.78315 0.69305 0.61332 Present Value [p = n*o] -4237000 612768.318 760579 762326 1607994 NPV -493333.5157 Post tax Salvage Value = 360000*(1-40%) = 216,000 Note : Cost of marketing firm is Sunk cost and It is not taken in consideration

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