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 $1.31 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 $1.41 million on an aftertax basis. In four years, the land could be sold for $1.51 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $116,000. 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 2,900, 3,800, 4,400, and 3,300 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $560 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 $380,000 per year, and variable costs are 10 percent of sales. The equipment necessary for production will cost $2.6 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $355,000. Net working capital of $116,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 14 percent. MACRS Schedule What is the NPV of the project?

Explanation / Answer

Sales Units 2900 3800 4400 3300 FC 380000 PER YEAR Sales Price 560 560 560 560 MACRS Schedule 3 years Depreciation Year Revenue 1624000 2128000 2464000 1848000 Equipment Cost 2600000 33.33% 866580 1 Varaible cost @10% 162400 212800 246400 184800 2600000 44.45% 1155700 2 Contribution 1461600 1915200 2217600 1663200 2600000 14.81% 385060 3 Fixed Cost 380000 380000 380000 380000 2600000 7.41% 192660 4 Net income before tax & Depreciation 1081600 1535200 1837600 1283200 Depreciation 866580 1155700 385060 192660 Net income before tax 215020 379500 1452540 1090540 Year Cash Flows PVF @ 14% Present Value Tax @ 40% 86008 151800 581016 436216 0 -2600000 1 -2600000 Net Income after tax 129012 227700 871524 654324 0 -116000 1 -116000 add: depreciation 866580 1155700 385060 192660 1 995592 0.877193 873326.32 After Tax cash Flows 995592 1383400 1256584 846984 2 1383400 0.769468 1064481.38 3 1256584 0.674972 848158.41 salvage value 355000 4 846984 0.59208 501482.52 after Tax Salvage value cash flows 213000 4 213000 0.59208 126113.10 4 116000 0.59208 68681.31 Net working capital 116000 NPV $ 766,243.04 Note: Land value does not matter Marketing survey sunk cost, not considered

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