Week 6 - Go Live Problem

You have been hired tas 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
yearfor 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 geel 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?
Week 6 - Go Live

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 = $ 190,000

Market Price $ 500,000

Tax on sale $ 190,000

Aftertax salvage value $ 310,000

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

Year 0 Year 1 Year 2 Year 3

Revenues $ 3,220,000 $ 4,567,500 $ 5,127,500
Fixed costs $ 725,000 $ 725,000 $ 725,000
Variable costs $ 483,000 $ 685,125 $ 769,125
Depreciation $ 1,566,510 $ 2,089,150 $ 696,070
EBT $ 445,490 $ 1,068,225 $ 2,937,305
Taxes $ 169,286 $ 405,926 $ 1,116,176
Net income $ 276,204 $ 662,300 $ 1,821,129
OCF $ 1,842,714 $ 2,751,450 $ 2,517,199

Capital spending $ (4,700,000)

Land $ (2,100,000)
NWC $ (450,000)
Total cash flow $ (7,250,000) $ 1,842,714 $ 2,751,450 $ 2,517,199

NPV $ 936,955.36

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

Calculation for Deprecation: Year 1 Year 2 Year 3

MACRS 3 years 33.33% 44.45% 14.81%
e to include in your capital

h to calculating operating

$ 19,400

Year 4
$ 3,395,000 Number of units X $175 each
$ 725,000
$ 509,250
$ 348,270
$ 1,812,480
$ 688,742
$ 1,123,738
$ 1,472,008

$ 310,000
$ 2,100,000
$ 450,000
$ 4,332,008

Year 4
7.41%