Question

You have been hired as a consultatnt for Pristne Urban-Tech Zither, Inc (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land 3 years ago for $1.8 million in anticipation of using it as a toxic waste dump site but has reently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $2.1 million on an aftertax basis. The company also hired a marketing firm to analyse the zither market, at a cost of $275,000. An excerpt of the marketing report is as follows: The zither industry will have a rapid expansion in the next 4 years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 18,400, 26,100, 29,300, and 19,400 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we eel that a premium price of $175 can be charged for each zither. Since 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 $725,000 per year, and variable costs are 15% of sales. The equipment necessary for production will cost $4.7 million and will be depreciated according to a 3 year MACRS schedule. At the end of the project, the equipment can be scrapped for $500,000. Net working capital of $450,000 will be required immediately and will be recaptured at the end of the project. PUTZ has a 38% tax rate and teh required return on the project is 13%. Required: What is the NPV of the project?

First, calculate the taxes on the salvage value in order to calculate the aftertax salvage value to include in your capital spending analysis (at the end of the project).

Taxes on salvage value =

Market Price:

Tax on sale:

Aftertax salvage value:

Now we need to calculate the operating cash flow each year. Using the bottom up approach to calculating operating cash flow, we find:

# of units per year 18,400 26,100 29,300 19,400

Year 0 Year 1 Year 2 Year 3 Year 4

Revenues

Fixed costs

Variable costs

Depreciation

EBT

Taxes

Net income

OCF

Capital spending

Land

NWC

Total cash flow

NPV

Should the company proceed with the project, yes or no?

Calculation for Deprecation: Year 1 Year 2 Year 3 Year 4

MACRS 3 years 33.33% 44.45% 14.81% 7.41%

Answer 1

	years	0	1	2	3	4
	salvage value of equipment
a	Sale value					500000
b= a*0.38	tax on salvage					190000
c= a-b	Cash flow due to salvage in yr 4					310000
	Depreciation
	Year	0	1	2	3	4
d	MACRS 3 year depreciation rate		33.33%	44.45%	14.18%	7.41%
e= d*4.7			1566510	2089150	696070	348270
	Opearting Cah flows
	years	0	1	2	3	4
f	no of units per years		18400	26100	29300	19400
g= f*$175	Sale revenue		3220000	4567500	5127500	3395000
h	Fixed cost		725000	725000	725000	725000
i=0.15*g	variable cost		483000	685125	769125	509250
e	depereciation		1566510	2089150	696070	348270
j=g-h-i-e	EBIT		445490	1068225	2937305	1812480
K=J*0.38	taxes		169286	405926	1116176	688742
l=j-k	net income		276204	662300	1821129	1123738
m=l+e	Opearting Cah flows		1842714	2751450	2517199	1472008
p	capital spenting	-4700000
	land	-2100000
	NWC	-450000				450000
	PRESENT VALUE OF CASH FLOW
	i= discount , r = rate return =13%
	n= no of cash flows
n	years	0	1	2	3	4
z=c+m+p+q+r	total after tax cash flow	($7250000)	1842714	2751450	2517199	2232008
pv= z/(1.13 n)	present value of cash flow	($7250000)	1630720	2154789	1744545	1368932
	net present value = [present value of cash inflow-outflow]	-351014
npv
	company should not proceed with the project because NPV is negative