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? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

Explanation / Answer

Answer Calculation of Net Income (in $) Year 1 2 3 4 Unit 2900 3800 4400 3300 price 560 560 560 560 Sales 1624000 2128000 2464000 1848000 Variable Cost 10% of sale 162400 212800 246400 184800 Fixed Cost 380000 380000 380000 380000 Depreciation 866580 1155700 385060 192660 EBIT 215020 379500 1452540 1090540 Tax 40% 86008 151800 581016 436216 Net Income 129012 227700 871524 654324 Calculation of NPV (in $) Year Net Income DF DCF 0 -2716000 1 -2716000 0 -116000 1 -116000 1 129012 0.877193 113168.4 2 227700 0.797448 181578.9 3 871524 0.724953 631813.8 4 654324 0.635924 416100.1 4 355000 0.63592 225751.6 NPV -1263587 Depreciation working 2600000 Value of assets Year % Depre. 1 33.33 866580 2 44.45 1155700 3 14.81 385060 4 7.41 192660 * Opportunity cost of land to sale in year 0 is not considered and also after 4 year sale of lands effect is not considered in calculation of NPV.

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