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 $1,240,000 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 $1,450,000 on an aftertax basis. In four years, the land could be sold for $1,475,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $180,000. 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 7,220, 8,120, 9,365, and 6,210 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $350 can be charged for each zither. Because zithers appear to be a fad, we feel at the end of the 4-year period, sales should be discontinued. PUTZ feels that fixed costs for the project will be $435,000 per year, and variable costs are 20 percent of sales. The equipment necessary for production will cost $3,950,000 and qualifies for 100 percent bonus depreciation. At the end of the project, the equipment can be scrapped for $420,000. Net working capital of $280,000 will be required immediately. PUTZ has a tax rate of 21 percent and the required return on the project is 14 percent. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.

Answer 1

N 0 2 3 4 a b Cost of Market Research($180,000) is a Sunk Cost It is not relevant for this analysis Present Value(PV) of Cash Flow: (Cash Flow)/((1+i)^N) i-discount rate=cost of Capital=14%=0.14 N=Year of Cash Flow Year INITIAL CASH FLOW Equipment Working Capital Opportunity cost of not selling land Total Initial Cash Flow ANNUAL CASH FLOW Sales in units Price per unit Unit Variable Cost (20%) Unit Contribution Margin Total Contribution Margin $3,950,000 -$280,000 -$1,450,000 -$5,680,000 Z I=a+b+z с d e=d*20% f=d-e 7,220 $350 $70 $280 $2,021,600 cur non 8,120 $350 $70 $280 $2,273,600 car non 9,365 $350 $70 $280 $2,622,200 car non 6,210 $350 $70 $280 $1,738,800 g=c*

z I=a+b+z $1,450,000 -$5,680,000 7,220 $350 $70 $280 $2,021,600 $435,000 $3,950,000 -$2,363,400 $1,867,086 $3,950,000 $2,082,914 8,120 $350 $70 $280 $2,273,600 $435,000 9,365 $350 $70 $280 $2,622,200 $435,000 d e=d*20% fed-e g=c*f h х i=g-h-Y Y=i*(1-0.21) X Z=Y+X 6,210 $350 $70 $280 $1,738,800 $435,000 Opportunity cost of not selling land Total Initial Cash Flow ANNUAL CASH FLOW Sales in units Price per unit Unit Variable Cost (20%) Unit Contribution Margin Total Contribution Margin Annual Fixed Costs (Before Depreciation) Depreciation expense Before Tax Profit Annual After tax Operating Income Add: Depreciation Operating Cash Flow Terminal Cash Flow: Release of working capital Cash flow from sale of land After tax scrap value(420000*(1-0.21) Total Terminal Cash Flow Net Cash Flow Present Valure Net Present Value(NPV) It is Financially acceptable NPV is positive $1,838,600 $1,452,494 $2,187,200 $1,727,888 $1,303,800 $1,030,002 $1,452,494 $1,727,888 $1,030,002 j k 1 T=j+k+1 CF=l+Z+T PV=CF/(1.144N) NPV =Sum of PV $ 280,000 $1,475,000 $331,800 $2,086,800 -$5,680,000 $2,082,914 $1,452,494 $1,727,888 $3,116,802 SUM $5,680,000.00 $1,827,117.54 $1,117,646.97 $1,166,275.18 $1,845,396.99 $276,436.69 $276,436.69