Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2763619 • 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 $135,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $590,000 per year. The fixed costs associated with this will be $194,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $650,000 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 12 percent.
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).)
Required: Calculate the Time 0 cash flow for this project. (Do not round intermediate calculations. Enter a negative sign when necessary. Round your answer to the nearest whole number (e.g., 32).)Explanation / Answer
Marketing serve is irrelevant for decision making. But we consider here as it is asked to calculate cash outflow at time 0.
= $135,000+ $650,000
= $785,000
The annual OCF for this project
Particulars
Amount
Sales
5,90,000
(-)Variable cost(20%)
118000
Contribution
4,72,000
(-)Fixed cost
1,94,000
(-) Depreciation
162500
EBIT
1,15,500
(-) Tax
34,650
EBT
80,850
(+) Depreciation
162500
Cash flow
2,43,350
= $650000/$243350
= 2.67 Years
NPV of the project
Figures in $
Year
Particulars
Amount
P.V Factor @ 12%
Total
0
Initial investment
-650000
1
-650000.00
1
Cash flow
243350
0.892857143
217276.79
2
Cash flow
243350
0.797193878
193997.13
3
Cash flow
243350
0.711780248
173211.72
4
Cash flow
243350
0.635518078
154653.32
NPV
89138.96
Internal rate of return (IRR) is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
We have to find IRR by assuming different discount rate by Trial and error method
Suppose discount rate is 18.3656%
NPV of the project
Figures in $
Year
Particulars
Amount
P.V Factor @ 18.3656%
Total
0
Initial investment
-650000
1
-650000.00
1
Cash flow
243350
0.844840055
205591.83
2
Cash flow
243350
0.713754718
173692.21
3
Cash flow
243350
0.603008575
146742.14
4
Cash flow
243350
0.509445798
123973.63
NPV
0.00
The annual OCF for this project
Particulars
Amount
Sales
5,90,000
(-)Variable cost(20%)
118000
Contribution
4,72,000
(-)Fixed cost
1,94,000
(-) Depreciation
162500
EBIT
1,15,500
(-) Tax
34,650
EBT
80,850
(+) Depreciation
162500
Cash flow
2,43,350
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