You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ),
ID: 2774060 • 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 $1.47 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 $1,570,000 on an aftertax basis. In four years, the land could be sold for $1,670,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $132,000. 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 4,500, 5,400, 6,000, and 4,900 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $720 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 $460,000 per year, and variable costs are 10 percent of sales. The equipment necessary for production will cost $4.20 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $435,000. Net working capital of $132,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 14 percent. Assume the company has other profitable projects. MACRS schedule.
What is the NPV of the project?
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 $1.47 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 $1,570,000 on an aftertax basis. In four years, the land could be sold for $1,670,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $132,000. An excerpt of the marketing report is as follows:
Explanation / Answer
Computation of the net present value is as follows: Amounts in dollars
It is the difference between the present value of cash inflows and that of outflows.
Year
Cash flow
Discount factor@14%
Discounted flow
0
-4,332,000
1
-4,332,000
1
2,033,544
0.8771
1,783,621
2
2,570,280
0.7694
1,977,573
3
2,305,608
0.6749
1,556,055
4
2,320,608
0.592
1,373,800
Total
2,359,049
Thus, the NPV of the project is $2,359,049.
Working notes:
Computing the cash flows:
Year
1
2
3
4
Sales units
4500
5400
6000
4900
Sale price
720
720
720
720
Sale value
3240000
3888000
4320000
3528000
Less:
Variable costs
324000
388800
432000
352800
Fixed costs
460000
460000
460000
460000
Depreciation
1399860
1866900
622020
311220
Income
1056140
1172300
2805980
2403980
Less:
Tax @40%
422456
468920
1122392
961592
Profit
633684
703380
1683588
1442388
Add:
Depreciation
1399860
1866900
622020
311220
Cash flows
2,033,544
2,570,280
2,305,608
1,753,608
The working capital is considered as cash outlay as well as cash inflow for the years.
Year
Cash flow
Discount factor@14%
Discounted flow
0
-4,332,000
1
-4,332,000
1
2,033,544
0.8771
1,783,621
2
2,570,280
0.7694
1,977,573
3
2,305,608
0.6749
1,556,055
4
2,320,608
0.592
1,373,800
Total
2,359,049
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