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 $2.85 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 $3.05 million on an aftertax basis. In four years, the land could be sold for $3.25 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $365,000. 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 7,000, 7,700, 8,300, and 6,600 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $520 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 $735,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $3.6 million and qualifies for 100 percent bonus depreciation in the first year. At the end of the project, the equipment can be scrapped for $605,000. Net working capital of $315,000 will be required immediately. PUTZ has a tax rate of 24 percent, and the required return on the project is 12 percent.

What is the NPV of the project?

Answer 1

Solution :-
Year	0	1	2	3	4
Initial Cost	-6965000
Sales (units)		7000	7700	8300	6600
Selling Price		520	520	520	520
Sales Value		3640000	4004000	4316000	3432000
Less :- VC @20%		728000	800800	863200	686400
Contribution		2912000	3203200	3452800	2745600
Less :- Fixed Exps		735000	735000	735000	735000
Less :- Dep		3600000
EBIT		-1423000	2468200	2717800	2010600
Add :- Tax Saving		341520
Less :- Tax Paid			592368	652272	482544
Net Income		-1081480	3060568	3370072	2493144
Add :- Dep		3600000
Cashflow		2518520	3060568	3370072	2493144
NWC Recovery					315000
After Tax Salvage					459800
Land					3250000
Net Cashflow	-6965000	2518520	3060568	3370072	6517944
PVF@12%	1	0.892857	0.797194	0.71178	0.635518
PV of Cashflow	-6965000	2248679	2439866	2398751	4142271
NPV	4264566.57

Working Notes:-  

Initial Cost
Land	3050000
Plant	3600000
Working Capital	315000
Total	6965000

Salvage Value after Tax
605000*(1-0.24)		459800