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 $1.38 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 $1,480,000 on an aftertax basis. In four years, the land could be sold for $1,580,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $123,000. 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 3,600, 4,500, 5,100, and 4,000 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $630 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 feels that fixed costs for the project will be $415,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $3.30 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $390,000. Net working capital of $123,000 will be required immediately. PUTZ has a 40 percent tax rate, and the required return on the project is 13 percent. Assume the company has other profitable projects. MACRS schedule. 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

Let us first have all the assumptions in place in order to do the calculation of NPV

Land purchased three years ago --- $1.38 Mn

Current Value of Land after Tax --- $ 1.48 Mn

Value of Land in 4 years after Tax ---$ 1.58 Mn

since the

Marketing Firm Consultancy Cost --$123,000 is to be treated as a sunk cost and would not feature into the calculation.

				Machinery Cost		3300000
Market price per unit		630				MARCS
	1	2	3	4		1	33.33%
Units sold	3600	4500	5100	4000		2	44.45%
Revenue	2268000	2835000	3213000	2520000		3	14.81%
Fixed Cost	415000	415000	415000	415000		4	7.41%
Variable Cost	340200	425250	481950	378000		Variable	15%
Depreciation	1099890	1466850	488730	244530		Reqd rate	13%
Working Cap	123000	0	0			Tax	40%
Residual Value				390000
Return of W/c				123000
Net Cash flow	289910	527900	1827320	1995470
Tax	115964	211160	730928	798188
After Tax Income	173946	316740	1096392	1197282
Investment	-3300000
PV of Cash in-Flows	1896158.52
NPV	-1403841.48
After Tax land Sale	1580000.00
NPV considering land sale	$176158.52

The cost of equipment is $3.3 Mn and working capital investment is $123000

The NPV considering only the investment in plant & machinery and the cash flows generated in the project is a negative -1403841.48 i.e this is a negative NPV project.

However if we consider the sale of the land (purchased earlier) at the end of the four year period then it has a positive NPV of $176158.52. But land should not be considered here because the land can be used for other alternative uses.