Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-d
ID: 2729844 • 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 $131,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $586,000 per year. The fixed costs associated with this will be $190,000 per year, and variable costs will amount to 21 percent of sales. The equipment necessary for production of the Potato Pet will cost $642,000 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 payback period for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Payback period years
Requirement 2: Calculate the NPV for this project. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) NPV $
Requirement 3: 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).) IRR %
Explanation / Answer
Pappy's Potato Assume the fixed cost per year is excluding depreciation. NPV details Year 0 Year 1 Year 2 Year 3 Year 4 Equipment Cost (642,000) Annual sales revenue 586,000 586,000 586,000 586,000 Less Variable cost @21% of sales (123,060) (123,060) (123,060) (123,060) Less Fixed costs (without depreciation ) (190,000) (190,000) (190,000) (190,000) Less Depreciation (160,500) (160,500) (160,500) (160,500) Taxable income 112,440 112,440 112,440 112,440 Tax @30% (33,732) (33,732) (33,732) (33,732) Post Tax income 78,708 78,708 78,708 78,708 Add back depreciation 160,500 160,500 160,500 160,500 Total Cash flows (642,000) 239,208 239,208 239,208 239,208 PV factor @12% 1.000 0.893 0.797 0.712 0.636 PV of net cash flows (642,000) 213,579 190,695 170,264 152,021 NPV = $ 84,558.26 Payback period in years = 2.68 NPV = $ 84,558.26 IRR calculation Year 0 Year 1 Year 2 Year 3 Year 4 Equipment Cost (642,000) Annual sales revenue 586,000 586,000 586,000 586,000 Less Variable cost @21% of sales (123,060) (123,060) (123,060) (123,060) Less Fixed costs (without depreciation ) (190,000) (190,000) (190,000) (190,000) Less Depreciation (160,500) (160,500) (160,500) (160,500) Taxable income 112,440 112,440 112,440 112,440 Tax @30% (33,732) (33,732) (33,732) (33,732) Post Tax income 78,708 78,708 78,708 78,708 Add back depreciation 160,500 160,500 160,500 160,500 Total Cash flows (642,000) 239,208 239,208 239,208 239,208 PV factor @18.119% 1.000 0.847 0.717 0.607 0.514 PV of net cash flows (642,000) 202,514 171,449 145,150 122,884 NPV = $ (1.94) So at required rate of return 18.119%, the NPV is almost 0. So IRR is 18.119%
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