Problem 9-20 Calculating Project Cash Flows and NPV [LO 2] Pappy?s Potato has co

Question

Problem 9-20 Calculating Project Cash Flows and NPV [LO 2] Pappy?s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy?s paid $136,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $591 ,000 per year. The fixed costs associated with this will be $195.000 per year, and variable costs will amount to 21 percent of sales. The equipment necessary for production of the Potato Pet will cost $652,000 and will be depreciated in a straight-line manner for the four years of the product life (as with all fads, it is felt the sales will end quickly). This is the only initial cost for the production. Pappy?s is in a 30 percent tax bracket and has a required return of 13 percent. Requirement 1: Calculate the payback period for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Payback period years Requirement?: Calculate the NPV for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) NPV $ Requirement 3: Calculate the IPR for this project. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) IRR

Explanation / Answer

The marketing spent has been ignored as it considered as sunk cost.

a) The net income is:

Revenue: 591,000
less fixed cost: 195,000
less variable: 591,000 * 0.21 = 124,110
less depreciation: 652,000 / 4 = 163,000
Net income after taxes: (591,000 - 195,000 - 124,110 - 163,000) * (1 - 0.30) = 76,223
Cash flow "CF": NI-AT + depreciation (a non cash expense) = 76,223 + 163,000 = $239,223

Payback period: 652,000 / 239,223 = 2.725 years
NPV: (652,000) + PVoa of the cash flows
PVordinary annuity "PVoa"...
PVoa = PMT [(1 - (1 / (1 + i)^n)) / i]
= 239,223[(1 - (1 / 1.13^4)) / 0.13]
= 239,223[(1 - 0.6133) / 0.13]
= 239,223[2.9744]
= 7,11,562
NPV: $59,561.95

IRR (use Excel spreadsheet): 17.33%

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