Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2779414 • 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 $130,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $585,000 per year. The fixed costs associated with this will be $189,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $640,000 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 34 percent tax bracket and has a required return of 15 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).)
Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy’s paid $130,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $585,000 per year. The fixed costs associated with this will be $189,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $640,000 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 34 percent tax bracket and has a required return of 15 percent.
Explanation / Answer
Step1: Calculation of Cash flow for the project at time 0.We have,
Cash flow for the project = Cost of Equipment + Cost of market survey
Cash flow for the project = 640,000 + 130,000 = $ 770,000
Hence, the cash flow for the project at time 0 is - $ 770,000
Step2: Calculation of annual OCF for the project.We have,
Step3: Calculation of payback period for the project.We have,
Payback period = Initial Investment / Constant annual cash flow
Payback period = 770,000 / 238,540
Payback period = 3.23 Years
Hence, the payback period for the project is 3.23 years.
Step4: Caluculation of Net present value(NPV) of the project.We have,
Present value of cash inflow = Cash inflow x PVFIFA(15%,4 years)
Present value of cash inflow = 238,540 x 2.8550 = $ 681,031.70
NPV of the project = Present value of cash inflow - Cash outflow
NPV of the project = 681,031.70 - 770,000 = - $ 88,973.46
Hence, the NPV of the project is - $ 88,973.46
Step5: Calculation of IRR of the project.We have,
Present value of cash inflow at 9% = 238,540 x 3.2397 = $ 772,802.78
IRR = r - [( PVCO - PVCFAT ) / difference in calculated present value of inflow] x Difference in interest rates
IRR = 15 - [ ( 770,000 - 681,031.70) / ( 772,802.78 - 681,031.70) ] X ( 15- 9)
IRR = 15 - 5.82 = 9.18 %
Hence, the IRR of the project is 9.18 %
Particulars Calculation Amount($) Sales 585,000 Less: Variable Cost 20% of 585,000 117,000 Contribution 468,000 Less: Fixed Cost: Operating Fixed cost 189,000 Depreciation (640,000 - 0) / 4 160,000 Profit before tax 119,000 Less: tax expense 119,000 x 34 % 40,460 Profit after tax 78,540 Add: Depreciation 160,000 Annual OCF for the project $ 238,540Related Questions
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