You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ),
ID: 2779170 • 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 $1.36 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 $1.46 million on an aftertax basis. In four years, the land could be sold for $1.56 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $121,000. 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 3,400, 4,300, 4,900, and 3,800 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $610 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 $405,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $3.10 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $380,000. Net working capital of $121,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 12 percent.
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))
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 3,400, 4,300, 4,900, and 3,800 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $610 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.
Explanation / Answer
Note : Selling price of land is not considered as it is not an incremental cash flow due to the project
Marketing research fee not considered as it is sunk cost
Marginal tax rate 40% Time line 0 1 2 3 4 Cost of equipment -3100000 +NWC -121000 =Initial Investment outlay -3221000 Number of units sold 3400 4300 4900 3800 Sales =number of units * premium 2074000 2623000 2989000 2318000 -variable cost =20% of sales 414800 524600 597800 463600 -Fixed cost 405000 405000 405000 405000 MACR rate 33.33% 44% 14.81% 7.41% -Depreciation =Cost of equipment * MACR %age 1033230 1377950 459110 229710 =Pre tax operating Cash flow 220970 315450 1527090 1219690 -taxes =Pre tax operating CF*(1-tax) 132582 189270 916254 731814 +Depreciation 1033230 1377950 459110 229710 =after tax operating cash flow 1165812 1567220 1375364 961524 Terminal cash flow Reversal of NWC 121000 After taxCash inflow due to sale =selling price* (1 - tax rate) 228000 Terminal year after tax non operating cash flow = 349000 Total Cash flow for the period -3221000 1165812 1567220 1375364 1310524 Discount rate= 12% Discount factor =(1 + discount rate)^n 1 1.12 1.2544 1.404928 1.57352 Discounted Cash flow =Cash flow for period/discount factor -3221000 1040904 1249378 978956.9 832862 NPV =Sum of discounted cash flow 881100.4Related Questions
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