Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2720514 • 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 $127,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $582,000 per year. The fixed costs associated with this will be $186,000 per year, and variable costs will amount to 22 percent of sales. The equipment necessary for production of the Potato Pet will cost $634,000 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.
Requirement #1: 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).)
Requirement #2: Calculate the annual OCF for this project. (Do not round intermediate calculations. Round your answer to the nearest whole number (e.g., 32).)
Explanation / Answer
(1) Time Zero cash flow means, the initial outlay is made at the start of the project. Time zero Cash flow the project = Equipement Cost = $634,000 Market Surveyt Cost = $127,000 Total Cash Outflow = 761,000
Actual market survey cost is sunk cost whethe to start the project for not. Some analyst do not consider it as time zero project cost.
(2) OCF (in $) : (Sales - Cost) x (1-Tax rate) + (Tax rate x Depreciation)
= 582000- (128040 +186000) + (1-0.30) +(0.30 x 634000/4)
OCF($) = 267960 + 47,550 = 315510
NPV of poject ($) = (PVIFA12%,4y x Net Cash flow) - 634,000
= (3.037 x 235122) - 634,000
= 714065.51- 634,000 = $80.065.51
Rough calculations are placed below.
Net cash flow 235122.
Since Market survey is sunk cost, it may be kept out of NPV calculations.
Amount($) Sales 582000 VC @22% -128040 Contribution 453960 Fixed Cost -186000 EBDT 267960 Depreciation -158500 EBT 109460 Tax @30% 32838 EAT 76622 Add bach Dep. 158500 EAT + dep 235122Related Questions
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