Safari File Edit View History Bookmarks Window Help A 2 Eg Wed Nov 15 9:43 AM Ja

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Safari File Edit View History Bookmarks Window Help A 2 Eg Wed Nov 15 9:43 AM Jacob Holt QE · ) 98, ezto.mheducation.com Chapter 9 EOCP Chegg Guided Solutions and Help Chegg.com 4. 20.00 points Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $136,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $591,000 per year. The fixed costs associated with this will be $195,000 per year, and variable costs will amount to 21 percent of sales. The equipment necessary for production of the Potato Pet will cost $652,000 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 30 percent and a required return of 13 percent. 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 years 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 References eBook &Resources; Worksheet Learning Objective: 09-02 Analyze a projects projected cash flows Difficulty: 1 Basic Section: 9.3 Pro Forma Financial Statements and Project Cash Flows 15

Explanation / Answer

Cost of market study is a sunk cost, and it should be ignored.

Calculate the operating cash flows of the company:

OCF = (Sales - Costs)*(1-tax) + Tax*depreciaiton

OCF = (591000-0.21*591000-195000)*(1-0.3) + 0.3*652000/4 = 239223.00 per year

Payback period = Cost/Annual cash flow = 652000/239223 = 2.72 years

NPV:

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

NPV = -652000 + 239223/(1+0.13)^1 + 239223/(1+0.13)^2 +  239223/(1+0.13)^3 +  239223/(1+0.13)^4 = $59561.95

IRR is the rate at which NPV = 0

NPV = -652000 + 239223/(1+IRR)^1 + 239223/(1+IRR)^2 +  239223/(1+IRR)^3 +  239223/(1+IRR)^4 = 0

By trail and error, IRR = 0.1733 = 17.33%

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