determine the viabilily Pappy\'s Potato has come up with a new product, the Pota

Question

determine the viabilily Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $139,000 for a marketing survey to determine the viability of the product It is felt that Potato Pet will generate sales of $594,000 per year. The fixed costs associated with this will be $198,000 per year, and variable costs will amount to 18 percent of sales. The equipment necessary for production of the Potato Pet will cost $658,000 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 has a tax rate of 40 percent and a required return of 12 percent eapmnt nss for produdtion r ihe s5s Calculate the payback period for this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Payback period Calculate the NPV for this project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $ Calculate the IRR for this project. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) IRR years

Explanation / Answer

1) Payback period = initial investment/Annual OCF = 658000/239248 = 2.75 years. (Answer) 2) NPV = PV of cash inflows - Initial investment. The cash inflows are in the form of an annuity. Therefore, NPV = 239248*(1.12^4-1)/(0.12*1.12^4) -658000 = $68679.76 (Answer) 3) IRR is that discount rate for which NPV = 0, or PV of cash inflows = Initial investment Hence, 658000=239248*PVIFA(irr,4), Solving for IRR 2.7503 = PVIFA(irr,4) Interest factors From the interest factor tables 2.7503 lies 16% 17% between the factors for 16% & 17%. 2.7982 2.7432 The value of irr can be found out by simple interpolation as below: irr = 16+ (2.7982-2.7503)/(2.7982-2.7432) = 16.87% (Answer) WORKSHEET FOR OPERATING CASH FLOW: Sales per year 594000 Variable cost (18% of sales) 106920 Fixed cost 198000 Depreciation (658000/4) 164500 Net operating income before tax 124580 Tax at 40% 49832 NOPAT 74748 Add depreciation 164500 Operating cash flow 239248

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