Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2722961 • 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 $120,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $575,000 per year. The fixed costs associated with this will be $179,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $620,000 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 40 percent tax bracket and has a required return of 13 percent. *What is the initial (t=0) cash outflows? What is the operating cash inflows at t=1? *What is the total cash flows (operating cash flows plus terminal cash flows) at t=4? *Compute the NPV and IRR of the project. Should this new project be accepted?
Explanation / Answer
Answer: Initial cash Outflows =-$620000
Answer: Operating cash Inflowsat t=1=$230600
Answer: Total cash flow=$230600
Answer:
Yes, this new project is accepted
Discount rate 13% Year 0 1 2 3 4 Intial cost -620000 Sales 575000 575000 575000 575000 Variable cost 115000 115000 115000 115000 Fixed cost 179000 179000 179000 179000 Depreciation 155000 155000 155000 155000 EBT 126000 126000 126000 126000 Less: tax @40% 50400 50400 50400 50400 EAT 75600 75600 75600 75600 Add: Dep 155000 155000 155000 155000 OCF 230600 230600 230600 230600 Cash Flows ($) -620000 230600 230600 230600 230600 NPV 65913.09 IRR 18.03%Related Questions
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