1. 34.

Calculating project NPV [LO 10.1] You have been hired as a consultant for Pristine Urban-Tech Zither Ltd, manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1.9 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 $2.1 million on an after-tax basis. In four years, the land could be sold for $2.3 million after taxes.

The company also hired a marketing firm to analyse the zither market, at a cost of $175 000. An excerpt of the marketing report is as follows:

1. The zither industry will have a rapid expansion in the next four years. With the brand name recognition that Pristine brings to bear, we feel that the company will be able to sell 5 100, 5 800, 6 400 and 4 700 units each year for the next four years, respectively. Again, capitalising on the name recognition of Pristine, we feel that a premium price of $425 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.

Pristine believes that fixed costs for the project will be $345 000 per year and variable costs are 15 per cent of sales. The equipment necessary for production will cost $2.65 million and will be depreciated on a straight-line basis over four years for tax purposes. At the end of the project, the equipment can be scrapped for $395 000.

Net working capital of $125 000 will be required immediately. Pristine has a tax rate of 30 per cent and the required return on the project is 13 per cent. What is the NPV of the project?