Economics
University of Cumberland's Net Present Value Is a Discounted Cash Flow Method Essay

University of Cumberland’s

Question Description

I need an explanation for this Economics question to help me study.

Year

Investment A

Investment B

0

-$5,000,000

-5,000,000

1

$1,500,000

$1,250,000

2

$1,500,000

$1,250,000

3

$1,500,000

$1,250,000

4

$1,500,000

$1,250,000

5

$1,500,000

$1,250,000

6

$1,500,000

$1,250,000

7

$2,000,000

$1,250,000

8

0

$1,600,000

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 $2.1 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 $2.3 million on an after-tax basis. In four years, the land could be sold for $2.4 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $125,000. 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, 4,300, 5,200, and 3,900 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $750 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 believes 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 $3.5 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $350,000. Net working capital of $125,000 will be required immediately. PUTZ has a 38 percent tax rate, and the required return on the project is 13 percent. What is the NPV of the project?

Provide your explanations and definitions in detail and be precise. Comment on your findings. Provide references for content when necessary. Provide your work in detail and explain in your own words. Support your statements with peer-reviewed in-text citation(s) and reference(s).

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Final Answer

Attached.

Running Head: NET PRESENT VALUE

1

Net Present Value
Student
Professor
Course
Date

NET PRESENT VALUE

2

Net Present Value is a Discounted Cash Flow (DFC) method - under capital budgeting that computes the projected earnings of an investment or a project by discounting its expected
future cash flows- both outflows and inflows- to the present point, with the use of a required rate
of return (Oliver, 2012). Alternatively, it can be defined as a summation of the total PV of the cash
flows in each period (Doss, Sumrall, & Jones, 2017). Positive Net Present Values are usually
considered for selection. To compute the NPV, we first should calculate the cash inflows and
outflows for the project, which is going to be implemented.
Computation of cash inflows from sales for 4 years
Year

1

2

3

Unit Price

$750

$750

$750

$750

Unit Sales

3600

4300

5200

3900

$2,700,000

$3,225,000

$3,900,000

$2,925,000

Total Sales

4

As asserted by the instructions, the unit price for each zither is $750. Additionally, it is
expected that the company will make 3600 sales in the 1st year, 4300 sales in its 2nd year, 5,200
sales in its 3rd year, and 3,900 sales in its 4th year. The total sales of each year are thus computed
by generated the unit price of $750 by the unit sales. Following this is to compute the cash
outflows, as shown in the table below 2. The question states that the fixed costs of each of the four
years are $415,000. The variable costs (VC), on the other hand, amounts to 15% of the total sales.
For this reason, the VC for the first year will be computed as (15%*2,700,000). This gives the
result of $405,500. The same procedure is followed for the other three years. The total cost is then
computed by adding up the variable cost of each year with the fixed cost of that year. For year one,
it will be: 415,000 + 405,000 = 820,000.

NET PRESENT VALUE

3
Computing Cash Outflows

Particulars
Fixed Cost (FC)

Year 1

Year 2

Year 3

Year 4

Amount

Amount

Amount

Amount

$415,000

$415,000

$415,000

$415,000

(15% of Sales)

$405,000.00

$483,750.00

$585,000.00

$438,750.00

Total Co...

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Cornell University

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