Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2761333 • Letter: P
Question
Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy’s paid $134,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $589,000 per year. The fixed costs associated with this will be $193,000 per year, and variable costs will amount to 18 percent of sales. The equipment necessary for production of the Potato Pet will cost $648,000 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 35 percent tax bracket and has a required return of 15 percent.
Calculate the payback period for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Calculate the NPV for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Calculate the IRR for this project. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy’s paid $134,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $589,000 per year. The fixed costs associated with this will be $193,000 per year, and variable costs will amount to 18 percent of sales. The equipment necessary for production of the Potato Pet will cost $648,000 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 35 percent tax bracket and has a required return of 15 percent.
Explanation / Answer
Before Tax Income= 589000-193000-(18%*589000)-(648000/4)= 127980 Years BT Income AT Income Annual Cash flow (AT Inc+Depn 162000) PV F @ 15% PV @ 15% Cumulative Pay back 0 -648000 1 -648000 -648000 1 127980 83187 245187 0.86957 213207.3 -434792.74 2 127980 83187 245187 0.75614 185395.7 -249397.04 3 127980 83187 245187 0.65752 161215.4 -88181.69 4 127980 83187 245187 0.57175 140185.7 52003.98 Net Present Value = 52003.98 Discounted Pay-back Period Formula for Discounted Pay-back Period Discounted Payback Period = A+(B/C) A = Last period with a negative discounted cumulative cash flow; B = Absolute value of discounted cumulative cash flow at the end of the period A; C = Discounted cash flow during the period after A. Pay back period 3+ 88181.69/140185.7 3+ 0.63 Ie. Approx 3.63 Yrs. Simple Pay back Initial Investment/Annual Cash flow ie. 648000/245187 2.64 Years IRR Rate at which the PV of Outflow equals the PVs of Inflows Formula for IRR= 245187/(1+r)^1+245187/(1+r)^2+245187/(1+r)^3+245187/(1+r)^4-648000=0 Solving for r, we get r= 0.18915 or 18.92% IRR (As per Excel Fn.) 18.92% ANSWERS The payback period for this project Discounted Pay-back Period 3.63 Yrs. Simple Pay back 2.64 Yrs. The NPV for this project 52003.98 IRR 18.92%
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